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AN INTRODUCTION TO 
ECONOMICS 



BY 

GRAHAM A. LAING, M.A. 

FORMERLY INSTRUCTOR IN ECONOMICS AND HISTORY 
UNIVERSITY OF CALIFORNIA 



THE GREGG PUBLISHING COMPANY 

NEW YORK BOSTON CHICAGO SAN FRANCISCO 

England : 21 Harrington Street, Liverpool 



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COPYRIGHT, 1919, BY THE 
GREGG PUBLISHING COMPANY 



AUG 20 '919 



©CLA530580 



PREFACE 

This book is designed as an introductory treatise on 
the science of Economics. In its preparation the author 
has had constantly in mind the demands of secondary 
schools for a textbook that lays stress upon the dis- 
cussion of economic principles with especial reference 
to American conditions. 

Two aims have been followed. First, to give a work- 
ing basis in the knowledge of the methods and terms 
to be used, and of the content of the subject, such as 
society as a developed organism, the laws of produc- 
tion, the methods and organization of production and 
exchange. The growth of productive methods from 
the time of communal working, through domestic 
manufacture to the factory system, has been carefully 
discussed. This discussion shows how manufacturing 
has developed from small units with hand labor to 
production on a large scale by machinery, which has 
resulted in the very large increase in trades and in- 
dustries. The meaning of the terms production and 
value, and the laws which govern the production of 
commodities, have been carefully explained. 

The second aim has been to present the methods 
employed in the application of economic principles, 
with especial reference to exchange. In dealing with 
the banking system, for example, a comprehensive 
account is given of the Federal Reserve System which 



IV PREFACE 

has played so important a part in the commercial 
organization of the United States during the past few 
years. Banking, as a general subject, has been con- 
sidered from the point of view of its function rather 
than of its technique. J 

Because of the importance of international trade in 
the future economic development of American industry, 
careful attention has been given to the principles in- 
volved, as well as to the closely related subject of 
foreign exchange. 

Throughout the book emphasis has been placed on 
the fact that all economic organization and industry 
are only a means to an end, and that, therefore, the 
welfare of those who carry on production must be given 
consideration. Labor problems have been treated 
without bias, as have also the suggestions for the re- 
construction of society. Exhaustive treatment of these 
subjects in^a textbook of this kind is impossible, but it 
is hoped that the student will feel that he has sufficient 
basis on which to build a real knowledge of those prob- 
lems with which he will, later on, be called upon to deal. 

Thanks are due to Professor Solomon Blum of the 
University of California for his interest and kindness 
in reading the manuscript, and to Professor F. R. 
Macaulay, for helpful suggestions and criticisms. 

Graham A. Laing 

Berkeley, Cal. 
May, 1919. 



CONTENTS 

CHAPTER I 

THE MEANING OF ECONOMICS 

PAGE 

Statement of the Problem of Living — Definition of Economics — 
Economics a Social Science — The Subject Matter of Economics 
— Economic Laws — The Deductive Method— The Syllogism— 
The Inductive Method — Value of Economic Laws — The Scope 
of Economics — Summary 1 

CHAPTER II 

THE THEORY OF ECONOMIC DEVELOPMENT 

Economic History — The Four Stages of Development — Definition 
of Economic Unit — Characteristics of Development — Relations 
between the Stages of Development — Variations in Rate of De- 
velopment — Modern Civilization Dynamic — Growth of Civiliza- 
tion Accompanied by Increase in Needs of Man — Physical 
and Conventional Necessities — The Economic Problem . . 15 

CHAPTER III 

THE COMPETITIVE SYSTEM 

Economic Freedom — Regulation of Industry — Production for Profit 
Most Satisfactory System — Basis of Argument in Favor of Pro- 
duction for Profit — Limitation to Demand for Necessities — The 
Idea of Competition — Meaning of Competition — Labor Viewed 
as a Commodity — Claims Made for the Competitive System — 
Some Defects of the Competitive System — Failure of Competi- 
tion — Change in Principle of Government Regulation — Sum- 
mary 

CHAPTER IV 

THE MEANING OF PRODUCTION 

Physical and Conventional Necessities — Characteristics of Civili- 
zation—Meaning of the Term PFeaZ</^ — Wealth Comprises 
Services as well as Material Goods — Utility, Distmguished 
from Usefulness — Consumption of Utilities — Production De- 



26 



VI CONTENTS 

page" 
termined by Consumption — Definition of Production — The 
Miner as a Producer — The Steel Manufacturer — The "Produc- 
tion" of a Ship — Agriculture as Production — Production of 
Utilities — Summary ......... 40 

CHAPTER V 

THE AGENTS OF PRODUCTION 

Meaning of the Word Land, as an Agent of Production — Meaning 
of Labor — Meaning of Capital — Capital and Consumer's 
Wealth — Classification of Forms of Capital — Circulating and 
Fixed Capital — Division of Labor under Capitalistic System — 
Scientific Labor — Specialization in Location of Industry . . 55 

CHAPTER VI 

THE LAWS OF PRODUCTION 

Production Stimulated by Profits — Production Secured through Ap- 
plication of Capital and Labor to Natural Resources — Necessity 
for a Certain Minimum Capital and Effects of Increases — 
The "Dose" of Capital and Labor — Law of Increasing Re- 
turns — Illustration from Ship-building Industry — Law of Di- 
minishing Returns — Graphic Illustration — Effect of the Opera- 
tion of the Laws of Increasing and Diminishing Returns . . 66 

CHAPTER VII 

THE ORGANIZATION OF PRODUCTION 

Distinction between Business and Industry — Early Trade — Mer- 
chant Fleets — Formation of Partnerships and Companies — 
Monopolies and Regulated Companies — The Chartered Com- 
panies — Advantage and Defects of Partnerships — Early Joint- 
stock Companies — Limited Liability — Government of the 
Modern Corporation — Bond Issues and Bondholders — Profits 
of Bond- and Stockholders — Improvements in Production 
Due to Corporation Form of Organization — Illustration from 
Banking Business — Department and Chain Stores ... 77 

CHAPTER VIII 

THE ORGANIZATION OF PRODUCTION {continued) 

Agriculture as Industry — Primitive Agriculture — Communal Till- 
age — Difficulties in the Way of Progress — Extensive Culture in 
America — Increased Use of Fixed Capital — Manufactures. 
Subordinate Nature of Early Manufacture — The Gild System — 
Manufacture on a Small Scale — The Factory System — In- 
creased Use of Fixed Capital in Manufacture — Complexity of 
Modern Trade Forms — Elimination of Waste — Problems of 
Production . .91 



CONTENTS VU 

CHAPTER IX 

THE ORGANIZATION OF CAPITAL 

PAGE 

Failure of Competition — Limitation of Competition. 1. The Cor- 
poration 2. Price Agreements — Example of Price Agreement. 

3. The Kartel 4. The Pool 5. Monopolies 6. The Trust 

7. The Holding Company — Uniform Object to Eliminate 
Competition — Effects of Monopoly Organization — Control of 
Monopolies — Justification of Monopolies . . . . .106 

CHAPTER X 

VALUE 

Meaning of the Term Value — Diminishing Utility — Marginal 
Utility — Present and Future Satisfaction — Effective Demand 

— Meaning of Price — Relations between Supply and Demand, 

and Price — Elasticity of Demand 120 

CHAPTER XI 

THE LAW OF SUPPLY AND DEMAND 

The Factors of Exchange — Strong and Weak Buyers and Sellers — 
The Demand Curve — Consumer's Surplus — The Supply Curve 

— Producer's Surplus — Market Price — Definition of Term 
Market — Limits of Price Fluctuation — Normal Price — The Flow 

of Capital 133 

CHAPTER XII 

MONOPOLY AND MONOPOLY PRICE 

Importance of Stability of Prices — Varieties of Monopolies — Monop- 
olies by Royal Grant — Patents and Copyrights — Trade Marks — 
Monopoly of Location — Necessity of Control of Production and 
Distribution — Definition of Monopoly — Factors in Determina- 
tion of Monopoly Price — Latent Competition — Elasticity of 
Demand 149 

CHAPTER XIII 

THE EVOLUTION OF MONEY 

Problems of Barter Exchange — Cattle Used as Money — Other Forms 
of Money — The Qualities Desirable in a Money Material — 
1. Value in use 2. Universal Acceptability 3. Divisibility 

4. Homogeneity 5. Portability 6. Durability 7. Stability 

8. Cognizability — Metals as Money — Remedies for Defects in 
Metallic Money — Coined Money — Definition of a Coin — De- 
basement of Coinage — Effects of Depreciated Coinage . . 160 



viii CONTENTS 



CHAPTER XIV 

SOME MONEY PROBLEMS 

] 

Seigniorage — Gresham's Law — Subsidiary Coinage — Token Money 

— Bimetallism — Position of Silver Dollars — United States 
Currency — Money and Price — Relation of Gold Supply to 
Prices — Fluctuations in the Demand for Currency — Elastic 
Currency — Effects of Issue of Fiat Money — Currency Infla- 
tion — Measurement of Prices. Index Numbers 

CHAPTER XV 

THE EVOLUTION OF THE BANKING SYSTEM 

Honesty the Basis of Economic Structure — Banks the Lubricants of 
Commerce — Beginning of the Deposit System — Bank Notes. 
Origin — The Deposit System — Necessity for Bank Deposit Re- 
serves — The Case of Two or More Banks — The Clearing House 

— Debtor and Creditor Banks — The Bank Loan — iVccommo- 
dation Loans — Capital Loans — Commercial Loan — Discount 

— Value of Discount System — Bank Notes .... 

CHAPTER XVI 

THE AMERICAN BANKING SYSTEM 

The National Banks, Early History — National Banking Act. 
1. Minimum of Capital 2. Bond Purchases and Note Issues 
3. Reserves — Bank Examinations — Criticism of the System 

— National Bank Notes — Redemption of Notes — National 
Notes as Currency — Perverse Elasticity — The Reserve System 

— Defects of the System — The Call Loan System — Reserves 
during Crisis 

CHAPTER XVII 

THE AMERICAN BANKING SYSTEM (continued) 

The Federal Reserve Banks — Control of Reserves by Individual 
Banks — Use of the Discount Rate — Rediscounts — The Federal 
Reserve Act — The Reserve System — Rediscount Market — 
Crises and Panics — The Discount Rate — Currency — Federal 
Reserve Notes 

CHAPTER XVIII 

THE FEDERAL RESERVE SYSTEM CONTINUED, WITH A NOTE ON THE 
CANADIAN BANKING SYSTEM 

Elasticity of Currency — Federal Reserve Bank Notes — Summary — 
~*'Note on the Canadian Banking System 



CONTENTS IX 

CHAPTER XIX 

THE NATURE AND MECHANISM OF TRADE 

PAGE 

The Nature of Trade — The Mechanism of Exchange — The Trade 

Acceptance . . . . 247 

CHAPTER XX 

INTERNATIONAL TRADE 

Meaning of the word International — Definition of Nation — Essen- 
tials of International Trade — Law of Comparative Cost — Ben- 
efits of International Trade — Theory of International Value 
— International Price — The Cost of Transport — The Equation 
of Indebtedness 254 

CHAPTER XXI 

DOMESTIC AND FOREIGN EXCHANGE 

Difficulties in Paying by Check — Gold or Currency Payments — 
Payment by Draft — Mint Par of Exchange — Method of Pay- 
ing for Foreign Goods — Finance Bills — Effect of the Time Ele- 
ment on the Price of Exchange — Effects of the Rate of Interest 
upon Exchange Rates — The Causes of Gold Movements . . 269 

CHAPTER XXII 

PROTECTION AND FREE TRADE 

Definitions of Protective and Revenue Taxation — Effect on Prices — 
Protection of Young Industries — The National System — The 
Mercantilist Argument — Cheap Labor — Dumping . . . 287 

CHAPTER XXIII 

INVESTMENT AND SPECULATION 

The Flow of Capital — Investment — Par and Investment Price — 
The Future Element in Business — Speculation — Stock and 
Share Investment — The Method of Stock Exchange Specula- 
tion — Grain and Produce Speculation — Speculation and the 
Stability of Prices — Control of Speculation .... 306 

CHAPTER XXIV 

RENT, INTEREST, AND PROFITS 

Distribution as an Economic Problem — Rent — Urban Rents — 

Quasi Rents — Interest — Profits — Summary Analysis . . 320 



X CONTENTS 

CHAPTER XXV 

THE PERSONAL DISTRIBUTION OF WEALTH 

PAGE 

Statistics — The Present Condition — The Causes of Wealth. 
1. Accidental Causes 2. Opportunity 3. Efficiency 4. Monopoly 
— The Causes of Poverty — Old Age, Sickness, and Death 
of Chief Wage Earner — Unemployment and Irregular Employ- 
ment — Low Wages — The Incentives to Wealth. 1. The Will 
to Live 2. The Acquisitive Instinct 3. Emulation 4. The 
Will to Power — The Incentives to Work — "The Joy of Work- 
ing" — The Creative Instinct — The Organizing Instinct — 
The Dominating Instinct 333 

CHAPTER XXVI 

THE REMUNERATION OF LABOR 

The Meaning of the Word Labor — Labor's Part in Production — 
Labor as a Commodity — Wage Theories. 1. The Iron Law — 
Money and Real Wages — The Method of Payment. 1 . Time 
Wages 2. Piece Wages 3. The Bonus Systems 4. Profit 
Sharing ........... 355 

CHAPTER XXVII 

THE ORGANIZATION OF LABOR 

The Origin of Labor Organizations — The Right to Organize — The 
Methods of Organization — ■ National Association — The Shop 
Steward Movement — Aims of Labor Organizations. 1. Collec- 
tive Bargaining 2. Standard Wage 3. Conditions of Labor 
4. Hours of Labor — Trade Union Methods — Arbitration and 
Conciliation — The Boycott and the Union Label — The Success 
of Trade Unionism 370 

CHAPTER XXVIII 

DISTRIBUTION AND THE L\BOR PROBLEM 

Profit Sharing — Co-operation — Co-operative Production — Equality 

of Taxation 389 

CHAPTER XXIX 

THE ECONOMIC FUNCTIONS OF GOVERNMENT 

Protective Functions — Regulative Functions — Operative Func- 
tions — Government or Private Ownership of Public Utilities — 
Lessons of the War — Illustration of Government Economic Ac- 
tivity during the War _ . . . 407 



CONTENTS XI 

CHAPTER XXX 

PROPOSALS FOR SOCIAL RECONSTRUCTION 

PAGE 

Economic Organization a Steady Growth — Society Dynamic, not 
Static — Failure of Communistic Experiments — Socialism — 
Socialist Criticisms — The Central Idea of Socialism — Revo- 
lutionary Socialism — State Socialism — Objections to Social- 
ism — Guild Socialism — Conclusion 424 

Bibliography • • 447 



AN INTRODUCTION TO ECONOMICS 

CHAPTER I 
THE MEANING OF ECONOMICS 

Statement of the Problem of Living — Most of the 
years of a man's hfe are occupied in the solution of 
the pressing problem of gaining a living. There is no 
more important problem to solve, and the fact that 
it is always solved in a more or less satisfactory man- 
ner does not detract from its importance. In all ages 
and places the provision of the fundamentals of life — 
food, clothing, and shelter — has been a paramount con- 
sideration, more pressing, perhaps, in primitive times 
when man lived from hand to mouth, but nevertheless 
essential in the highest civilization. 

But the problem is not merely to gain a living some- 
how: it is to gain it with the least effort and in the 
fullest possible degree. Our lives are fuller and more 
worth living than those of the earlier inhabitants of the 
world who strove with the primal forces of nature. 
We have learned to subdue nature, to understand her, 
and to use the abundance of her resources to a greater 
extent than ever formerly. Yet we have still a vast 
amount to learn. We have not yet used to anything 
like the greatest possible degree the knowledge that 

1 



2 AN INTRODUCTION TO ECONOMICS 

our scientists have gained for us. Probably the bulk 
of the inhabitants of the modern world still live from 
hand to mouth as did their prehistoric ancestors, 
although it is true that they enjoy many advantages 
which were lacking in more primitive times. 

We cannot, therefore, consider the problem solved 
as yet. And it will not be solved unless very careful 
attention is devoted to the study of the best means of ' 
using the resources of the earth. Our study, therefore, 
resolves itself into a realization of the fact that we 
are in possession of a world of vast possibility in the 
production of the necessities of existence, and a con- 
sideration of the best means by which these possibilities ; 
may be made actualities not only to a few individuals, 
but to all the inhabitants of the world. 

Definition of Economics — Economics, therefore, ' 
may be defined as the study of man in regard to his 
activities in gaining a living. 

We must be careful, however, to see that we do not 
narrow our study to the provision of the physical 
necessities of existence. It is true that a man can live 
on a certain minimum of food, clothing, and shelter. 
If his food be sufficient to keep body and soul together 
and his clothing adequate to protect him from the 
extremes of climate, he can live. But man does not 
live by bread alone. Much more goes to the fulfillment 
of the highest possibilities of life. Variety in food, 
convenience and art in clothing, space and beauty in 
architecture are becoming more and more necessary. 
Literature, art, music are all real necessities although 
the physical being can be supported without them. In 
short, man wants to do more than exist; he wants to 



THE MEANING OF ECONOMICS 3 

live; to gain the fullest possible returns from the 
exertion of his powers. 

The study of economics is not mercenary or ignoble. 
The whole of the graces and beauties of life are 
dependent upon a sound basis of economic life. To 
put it crudely, the pursuit of wealth for its own sake 
may be unworthy and mean, but without wealth all 
the better sides of life are impossible. 

Economics a Social Science — Consequently eco- 
nomics is related to all other social sciences. It is 
related to history, which is the record of the past 
activities of man; it is related to psychology, which 
is the study of his mental processes ; it is related to 
geography, which is the study of the earth upon which 
he lives ; it is related to ethics, which is the study of 
his morals ; and to religion, which is the study of his 
hopes and aspirations. 

The fact of these relations, however, does not 
prevent us from studying economics as a separate 
science. It differs in some important essentials from 
the other subjects. It differs from history in that it is 
as much concerned with the future as with the present 
or past, and yet its basis is in history, for without 
history we cannot interpret the present or attempt to 
see our way in the future. Economics utilizes geog- 
raphy as the science which explains the phenomena 
of earth resources with which man as an economic 
animal must deal. Psychology is essential as an 
instrument whereby we can understand the mental 
processes which lead to man's actions. And ethics 
and religion provide the aims towards which economic 
activity should lead. 



4 AN INTRODUCTION TO ECONOMICS 

This does not mean that the study of all these sub- 
jects in careful detail is necessary for the understanding 
of the main principles of economics, but it does em- 
phasize the fact that economics is a branch, and not the 
least important branch, of the great group of sciences 
which are generally known as the social sciences. 

Economics is peculiarly a social science, in that it 
concerns man, not as an individual, but as a society or 
group. The vagaries of action in the individual are 
impossible to predict, but the action of a group under 
given circumstances can often be predicted with almost 
mathematical accuracy. This fact must be constantly 
borne in mind. In economics we are not dealing with 
any particular Mr. Smith or Mr. Robinson, but with 
man as averaged in groups. The insurance company 
with a hundred thousand pohcyholders cannot say 
which particular policyholder will die in any given 
year. But it can predict within very close limits how 
many of the policyholders will die in that year. In 
fact, if it were not able to do so, there would be no possi- 
bility of the existence of an insurance company. 

If a banking institution in a certain city should fail, , 
it would be impossible to say how the failure would 
affect the individual depositors and shareholders. But 
it would be a much easier matter to predict how the 
failure would affect the commercial community in 
which the bank was situated. The individual man is 
affected by all sorts of private and individual con- 
siderations. But these cancel one another in the large 
group, and only those effects which are directly the 
result of the economic cause are seen. Hence in our 
study we can afford to ignore all private considerations. 



THE MEANING OF ECONOMICS 5 

But while we ignore them, we must not be bhnd to 
their existence. We must constantly realize that we 
are deahng with averages. This is a commonplace of 
science. In chemistry we study the individual elements 
although probably most of them are seldom found in 
the pure state. In physics we study simple laws of 
motion before we consider the effects of modifying 
forces. 

The Subject Matter of Economics — We may now 
turn to the question of the nature of the material 
which forms the subject matter of economics. Without 
exhausting the material, we may say that, funda- 
mentally, economics examines into the causes which 
affect the production, distribution, and consumption 
of wealth; and in that examination, the study of the 
organization of industry and trade, the mechanism of 
exchange, the relations between employer and employed 
is essential. The nature of the control exerted upon 
economic processes' by individuals and by governments 
falls naturally into its place in the general study. 

All social existence necessitates a certain amount of 
organization and government, and the proportioning 
of the expense of securing this organization and govern- 
ment also forms part of the study of economics. That 
is to say, part of the subject consists in the study of the 
extent and methods of taxation, and part also in the 
extent and nature of governmental expenditure. 

It will readily be seen, therefore, that economics 
touches very closely upon the allied subjects of political 
science and history. The basis of the study must be 
in history, however. Nature does not progress by 
leaps and bounds, but by slow processes, and the 



6 AN INTRODUCTION TO ECONOMICS 

development of a civilization is no exception to the 
rule. Each institution is more a growth than an in- 
vention. We can trace our present institutions back 
to the past, and show how the gradual changes have 
been made to secure the remedies for the faults which 
have appeared with varying conditions. No institution 
is ever perfect ; all are adaptations of older ideas to new 
conditions. And so we cannot understand our existing 
institutions without understanding also the conditions 
which gave them birth. 

We are studying economic conditions and institutions, 
however, and are not concerned with institutions which 
have no economic importance. We are not called upon 
to make an exhaustive study of all the historic in- 
fluences which have helped to mold the present civiliza- 
tion. We are concerned merely with that portion of 
history which may be called economic history. In other 
words, we must study those historical conditions which 
have directly led to the establishment and growth of 
our modern economic organization. Again, in this 
connection, we must remember that economic history 
is only a part of general history. In the same way 
religious history is a part, as well as constitutional and 
legal history. We are not supposing that all develop- 
ment is due to economic conditions, but we do suppose 
that economic conditions have had a very important 
influence upon our development, and that they will 
continue to do so. 

Economic Laws — In the study of this historical 
development, the economist is not interested merely in 
facts. What he aims at is the correlation of facts so 
that he can trace the causes which have produced the 



THE MEANING OF ECONOMICS 7 

effects he wishes to study. Just so the scientist is not 
interested in the phenomena which he investigates 
purely for themselves, but for the purpose of explaining 
the phenomena, and evolving from his continued studies 
the laws which govern the actions of nature. The 
scientist seeks to discover scientific laws. The econo- 
mist seeks to discover economic laws. 

There are two meanings which we can attach to the 
word law. We may speak of laws as a legislator uses the 
term. That is, we may consider them as commands 
laid down by those in authority to be obeyed by the 
people. A scientific or natural law is not of this nature. 
The scientist does not say that all bodies shall be 
mutually attractive but that, on the contrary, all 
bodies, as a matter of fact, are so. In other words, the 
legal law is a command which is often disobeyed and 
penalties are imposed on the disobedient. The natural 
law is never disobeyed and consequently there are no 
penalties for disobedience. The natural law states 
that, given certain causes, certain results must ensue. 
It is this latter idea of law which is used in regard to 
the term economic law. An economic law is a state- 
ment of the tendency for certain economic results to 
follow upon certain given economic causes or conditions. 
It is of the utmost importance to remember this fact 
if the student is to avoid the common errors in the 
colloquial use of the term economic law. 

There is nothing final about an economic law any 
more than there is about a natural law. Whenever a 
scientist formulates a new natural law, he proceeds to 
test its validity by creating the given conditions and 
then watching for the results. As long as his " law " 



8 AN INTRODUCTION TO ECONOMICS 

! 

always satisfactorily explains the results, it is con- 
sidered as valid. But the moment a case arises which 
is not covered by the law, then the law must be re- 
stated so that it covers the new facts. This is exactly 
the case with the economist. His laws are valid only so 
long as they fit the facts. If they do not fit the facts, 
then thej^ must either be stated in such a manner that 
they do fit them, or else they must be discarded al- 
together. 

The Deductive Method — In order that a law once 
formulated shall stand the tests to which it must be 
put, it is obviously of extreme importance that the 
methods by which it is formulated should be sound. 
Essentially there are two processes of discovering these 
laws. They may, for example, be formulated on the 
mathematical method. In geometry, for instance, we 
postulate certain facts, and from the basis of these 
postulates, we develop, by a process of pure reasoning, 
certain conclusions. That is, we use the method of 
logic, the syllogism. The syllogism consists of three 
parts. First there is a general statement; this is 
followed by a subordinate statement related to the 
first. From these two statements a conclusion is 
reached. Let us take an example of such reasoning in 
order better to understand the method. 

The Syllogism — The general statement is usually 
termed the Major Premise, the second or subordinate 
statement is the Minor Premise, and the third is the 
Conclusion. 

Major Premise. True colonization is impossible unless 
permanent residence of the colonist is 
possible. 



THE MEANING OF ECONOMICS 9 

Minor Premise. Permanent residence of British colonists in 
India is impossible on account of the 
climate. 

Conclusion. British occupation of India cannot be true 

colonisation. 

Now the only way in which we can test the truth of 
this conclusion is to see whether it fits the observed 
facts. In this case the conclusion is sound, for it 
satisfies all the facts. But sometimes we find that the 
conclusion is not justified by the facts. For example, 
take the following argument. 

All workmen desire the highest wages they can get. 
All workmen are free to move wherever they will. 
Therefore a rise in wages in one part cf a country will 
attract workmen from other parts. 

In this case the facts do not always agree with the 
conclusion. Either something is wrong with our 
conclusion, or else with our premises. Though we 
may admit the general truth of the major premise, we 
cannot altogether admit the truth of the minor. There 
may be no legal objection to the free movement of 
workmen from one place to another, but nevertheless 
there are many other objections which tend to prevent 
such movement. A workman may not wish to leave 
his present home, or his friends ; he may not know of the 
rise in wages in the other place ; there may be conditions 
of climate or situation which make the other place less 
attractive, and so on. Hence our conclusion is not 
justified because the premises are not complete. 

It is obvious, therefore, that we must exercise great 
care in examining our premises before we draw, our 



10 AN INTRODUCTION TO ECONOMICS 

conclusion. And when we have so examined our 
premises, then we must apply the conclusion to the 
facts. This is always the ultimate test. If our con- 
clusion, or " law " does not fit the facts, then it is 
worthless, no matter how logically it may be drawn. 

The Inductive Method — This mathematical method 
of reasoning is usually called the deductive method. 
But it is not the only way in which we can formulate 
those economic laws about which the greater part of 
our study is concerned. If we note that in past ages a 
certain result has always followed upon certain causes, 
we may believe that in the future there is every reason 
for supposing that that result will continue to follow 
on the same cause. To take a concrete example, 
suppose that, on examination, we find that every time 
slave labor has been abolished and free labor sub- 
stituted, there has been an increase in efficiency of labor 
and generally a more abundant and better production ; 
and if we further note that in all cases where there has 
been an increase in individual freedom the product of 
the labor has been improved in quantity and in quality, 
then we may formulate the " law " that " free labor is 
more efficient than slave labor." Now it must be 
noted in this case that there is no attempt at deductive 
reasoning. We have merely observed certain facts 
and seen that in every case the same result has followed 
upon the given causes. There is always a possibility, 
of course, that in some future time we may find that 
the result does not follow as before. In that case, we 
must restate the law so that it meets the new condition, 
or else we must try to see whether there are not some 
other circumstances present which have been absent 



THE MEANING OF ECONOMICS 11 

in the previous cases from which our law has been 
formulated. 

This may seem an unscientific method of reaching 
conclusions, but in fact it is one of the commonest of 
the methods used in natural science. The familiar 
story of the discovery of the law of gravitation by 
Newton is an instance. ^Newton noticed that without 
support the apple was bound to fall from the tree, 
and that similarly any other body suspended above the 
surface of the earth was bound to fall as soon as its 
support was removed. From these elementary facts 
and from further close observation, Newton was able 
to formulate the law that all bodies tend to attract 
one another with a force varying inversely as the 
square of the distance, and directly as the mass of the 
bodies. Test after test produced the same result and 
hence we have accepted the law as true. 

The same method must be used in the discovery of 
economic laws and the same tests applied. The con- 
stant application of the law to existing facts tends to 
make the statement of the law more and more satis- 
factory. This process of discovering economic or 
other laws is called the inductive method. % til 

Value of Economic Laws — A natural question to 
ask is, wha{ is the value of these economic laws ? 
Without systematization there can be no real knowl- 
edge. In fact science is distinguished from ordinary 
knowledge merely because it is systematized or or- 
ganized. The value of the laws discovered in physical 
science is that not only can the present be explained, 
but the future can be predicted. If the economic 
laws are to be of any real value, they must enable 



12 AN INTRODUCTION TO ECONOMICS 

US to avoid errors in development by predicting tht„ 
future, at any rate to the extent of warning us of 
dangers which from all past experience seem bound 
to occur if a certain course is persisted in. In other 
words, the discovery and statement of economic laws 
helps to prevent the recurrence of past mistakes 
and to secure a sound and steady development in the 
future. 

From this, there arises the question of the scope of 
the economist's activities. ^Is he merely concerned 
with the analysis of past and existing economic con- 
ditions and reducing them to order, or should he 
also attempt to show how the existing system can be 
improved ? 

The Scope of Economics — Primarily we may say 
that the economist is purely an analyst. We do not 
expect the professor of physics to invent new machines. 
We leave that to the inventor or engineer who applies 
in practice what the professor of physics teaches and 
discovers in theory. Similarly we may say that the 
statesman applies in practice the theories developed 
by the economist. But the economist is a human being 
with a human being's inabihty to limit himself absolutely 
to one thing. He sees perhaps more clearly than any 
other the faults of the existing system of organization, 
for no one will attempt to deny that it has great faults. 
Moreover, he sees the evil effects of remedies suggested 
by people who have no clear knowledge of the causes of 
the evils, or of the remedies which have been attempted 
in the past. 

The economist finds himself intrenching upon the 
scope of the student of ethics and often of that of the 



THE MEANING OF ECONOMICS 13 

preacher, but he limits himself to a definite line of 
action. He is concerned primarily with the develop- 
ment of economic organization, but wherever that 
organization is affected by ethical and religious ideas, 
then he must consider the effects of those ideas, 
i Summary — We may now sum up the conclusions 
we have arrived at in this chapter. Economics is the 
science which deals with man in regard to his means of 
gaining a living. It is concerned, therefore, with such 
subjects as the production, exchange, and distribution 
of wealth; the organized relations between employer 
and employed ; the economic actions of government in 
securing a revenue and then in expending that revenue ; 
and, in short, with all matters that affect the physical 
well-being of mankind. 

I Economics deals with societies of men rather than 
with individuals, but recognizes that societies consist 
of groups of individuals. And so, while no particular 
Mr. Smith or Mr. Robinson can be considered, the 
welfare of all the Smiths and Robinsons is the ultimate 
aim of all social study. 

The economist analyzes the past and present eco- 
nomic conditions and organizations with a view to 
explaining them and to pointing out the reasons for 
their failure, or at least for the constant change which 
these institutions and organizations have undergone. 

And finally, the economist, realizing that the present 
system is very far from being the most satisfactory 
possible, endeavors to give sound criticism to all 
schemes of proposed reform and also to formulate 
schemes himself, basing those schemes or suggestions 
on his scientific knowledge of the present. 



14 AN INTRODUCTION TO ECONOMICS 

We have therefore undertaken a study of a science 
which, while it is not to be regarded at present as being 
complete, is one of immense importance to the world. 
Without it, all efforts at improving the condition of 
mankind will be of little avail. 



CHAPTER II 
THE THEORY OF ECONOMIC DEVELOPMENT 

Economic History — A good deal was said in the 
last chapter regarding the importance of history in the 
study of economics. It is impossible, even if it were 
desirable, to give a complete account of economic de- 
velopment in the present study. Nevertheless it is 
possible to indicate the general theory of economic 
development so that the reader may have the necessary 
basis for the future study. History is not a mere hap- 
hazard study of unrelated facts. Facts in themselves 
are not important ; it is in their significance that their 
importance lies. The whole value of the study of the 
facts and events of history lies in the possibility of 
determining the nature of historical progress. The 
antiquary is interested in the life of the past apart 
from all consideration of the influence of the past upon 
the present, but the antiquary and his studies are of 
no importance to the economist. What we want to 
find out is whether there are any laws of development ; 
that is, whether economic growth is the result of acci- 
dent or of a definite method of development. 

Nothing happens in nature without a cause. The 
effects of certain causes become themselves the cause 
of future events and if we could discover it, we should 
find that there is a definite chain of causes and effects 

15 



16 AN INTRODUCTION TO ECONOMICS 

going right back to primitive history. The tracing 
of that chain of events belongs to the study of history, 
but the results of the historian's work must be used 
by the economist. 

We can realize that there is a definite line of progress 
leading from a simple organization to a more complex 
until we arrive at the extreme complexity of the modern 
economic structure. What that line is we must now 
proceed to indicate. 

The Four Stages of Development — In the main we 
may distinguish four chief periods in the development 
of the human race. The first is the period of depend- 
ent life, the second is that of pastoral life, and the 
third the agricultural period. The final stage is that 
of industrial life. 

The Dependent Period — In primitive times man was 
dependent upon what he could reap from nature without 
contributing himself. He obtained his food either from 
the roots and fruits which grew wild or from hunt- 
ing wild animals. The results of the chase brought 
him his food and his clothing, as well as, in those 
climates where shelter was necessary, his shelter. He 
ate the meat of the animals he killed and used the 
skins either to clothe himself or to provide a tent in 
which to sleep. He contributed nothing to nature. 
He took what existed, and left the provision of his 
future needs to the powers of unaided nature. His 
life was, therefore, entirely dependent upon the simple, 
natural productions, and existence was necessarily 
hand to mouth. In other words, he lived the life of 
the wild animal, producing nothing himself. If nature 
were bountiful, he lived well. If nature were niggardly;, 



THE THEORY OF ECONOMIC DEVELOPMENT 17 

then his existence became a fight against starvation. 
Nature unaided tends in most cHmates to be niggardly, 
and hence the whole of life was taken up with the 
struggle for existence. 

The Pastoral Period — The first great development 
took place when man learned to tame the hitherto wild 
animals. He ceased to be entirely dependent upon the 
chase. His food and clothing became more certain 
and, what was of infinite importance, he was able to 
associate in larger groups than formerly. Life ceased 
to be the absolute hand-to-mouth existence that it 
was in the more primitive times. The comparative 
leisure enabled him to add to his knowledge and to 
develop his mind. The pastoral life in itself tended to 
encourage the contemplative form of life, and hence 
paved the way for a higher type of mind as well as for 
a better nourished body. We do not need to depend 
entirely upon conjecture to know that these two stages 
of development actually existed. We know that the 
Indians of America lived very largely in the dependent 
stage. They lived upon the fruits of the chase, clothing 
themselves and providing their tents from the skins 
of the animals they killed. Many existing races still 
live in the pastoral stage. Perhaps as good a descrip- 
tion of the life as can be given is contained in those 
chapters of the book of Genesis which deal with the 
life of Abraham and Lot. The constant traveling 
from place to place as pasture after pasture is ex- ' 
hausted; the gradual growth of the flocks of each 
until eventually there is not room for both in the same 
district; and the consequent separation, are typical 
of the life. 



18 AN INTRODUCTION TO ECONOMICS 

It is well to notice in this connection that in the 
more primitive method of living the group is smaller. 
The hunting life does not support a large group. Game 
moves away where the danger is too great and hence 
the group must split up in pursuit of new hunting 
grounds. The pasture is exhausted rapidly with large 
flocks, but nevertheless the pastoral group is larger 
than the hunting group. 

The Agricultural Stage — When the next stage of 
development arrives, there is opportunity for the 
growth of a much larger group. The pastoral group 
is less absolutely dependent upon the gifts of nature 
than the hunting group but the agricultural stage 
means a still greater addition to the human effort with 
a consequent lessening of the dependence upon un- 
aided nature. The farmer tills the soil and so makes 
greater use of the powers of nature. He is not com- 
pelled to move constantly from place to place in order 
to supply the needs of his existence. More people can 
be cared for on a given area than under either of the 
preceding stages. Hence we find that the groups are 
larger and the consequent closer association of mind 
with mind produces a still higher type of intelligence 
than has been possible before. It is true that the 
earliest forms of agriculture were extremely crude. 
Soil was very rapidly exhausted by continuous cropping 
with the same crops, and hence there were movements 
to new, virgin soil. But the gradual advance of agri- 
cultural knowledge made it possible to prolong the 
productive life of the soil and so the necessity to move 
to new lands became less and less frequent. 

The Industrial Stage — This gradual development 



THE THEORY OF ECONOMIC DEVELOPMENT 19 

of economic organization led to the growth of that 
principle which has been of the greatest service in 
rendering possible the complex life of the present day. 
The principle is that of the division of labor. Even in 
primitive times a certain amount of specialization of 
labor was possible. We read in accounts of primitive 
tribes, such as those described in Longfellow's Hia- 
watha, that even in groups that supported themselves 
entirely by hunting there were members of the group 
especially skilled in the making of instruments of the 
chase — makers of arrowheads, for instance. Ob- 
viously the man who devoted most of his time to the 
making of arrows could not spend much time in actual 
hunting, and so he had to exchange the products of his 
industry for those of the hunters. And the more 
skillful became the arrow maker, the more dependent 
upon him were the actual hunters themselves whose 
time was taken up in the use of the weapons provided 
by the arrow maker. 

Definition of Economic Unit — This becomes more 
and more true as the specialization advances. When 
the maker of weapons is supplemented by the maker 
of agricultural implements, and he in turn by the tent 
maker and later the builder, we notice a gradual in- 
crease in the interdependence of the members of a 
community. When we find one group which provides 
for itself all the necessities of life, without being de- 
pendent to any extent upon the produce of any other 
group, we call that group an economic unit. With 
each improvement in organization there is an extension 
of the economic unit. The more the individuals who 
compose a unit specialize in some form of production 



20 AN INTRODUCTION TO ECONOMICS 

or other, the more are the members of the group de- 
pendent upon each other. And also, the more members 
can the group sustain. 

Characteristics of Development — The natural de- 
velopment resultant upon this increase in specialization 
or division of labor is the rise of the latest stage in 
existence, the industrial stage. In this stage of de- 
velopment we see a steadily increasing interdependence 
of the members of a group and a steadily increasing 
number of members in the group. We are at present 
living in the industrial stage of civilization which seems 
to be the ultimate form. Specialization is carried to 
a very high degree. Instead of having a very few vari- 
eties of employment, the possible varieties are infinite 
and are increasing day by day. Industries which in 
the time of our fathers were units are now subdivided 
to a degree undreamed of in the past generation. A 
shipbuilder, for instance, no longer designs the boat, 
cuts the lumber, shapes and erects it, and finally paints 
the hull. The design is cared for by a naval architect. 
It is drawn by a draftsman. The drawing is printed 
in a blue-print office; the blue prints are used by the 
loftsmen to make the templates ; the templates are 
used by the shipwrights to make the shapes and so 
forth, until the list of trades concerned in the produc- 
tion of ships looks like a catalogue of all possible in- 
dustries. This instance could be multiplied to an 
unlimited extent. In 1776, Adam Smith was amazed 
at the number of operations which were necessary in 
the manufacture of a common pin. He enumerated 
eighteen. It is safe to say that there are a hundred 
now. 



THE THEOEY OF ECONOMIC DEVELOPMENT 21 

Relations between the Stages of Development — It 
must not be thought that these stages of development 
are definitely distinct from one another. At the present 
time we make use of all three methods of securing our 
necessities. The fish we eat are procured by methods 
comparable to those of the hunting stage of existence, 
although it is true that our means of catching fish are 
better than those of primitive times ; and it is also 
true that we do what was not thought of in purely 
dependent times — we try to restore what we take 
from the sea by cultivating the spawn of fish, as in the 
salmon trade, for instance. Our meat is the product 
of the pastoral life, although the cowboy of the western 
plains is hardly the same type as the Arabian shepherd. 
And our crops are the product of the agricultural stage. 
Each succeeding stage is rather superimposed on the 
previous than a substitute for it. 

Variations in Rate of Development — One distinc- 
tion is important, however. Progress was very slow 
in primitive times. It is very rapid now. The change 
from the dependent to the pastoral life probably oc- 
cupied many centuries. The development of primi- 
tive agriculture was probably much quicker in following, 
and the germs of the industrial stage were to be seen 
before the agricultural stage had made much headway. 

In the industrial stage the development has been 
increasingly rapid. There is more difference between 
the workman's occupation in the twentieth century 
and in the early nineteenth, than between the life of 
the eighteenth-century laborer and that of the twelfth- 
century workman. This is largely because the de- 
velopment is ceasing to be unconscious as it was in the 



22 AN INTRODUCTION TO ECONOMICS 

earlier times and is becoming increasingly conscious. 
That is to say, in early times changes were very slight 
and were introduced very gradually, so gradually, in 
fact, that they were not noticed. It is probable, in- 
deed, that they would not have been introduced at 
all had they been noticeable. Primitive man was 
resentful of change and even at the present day we 
notice a much stronger tendency to conservatism in 
backward peoples than in more enlightened races. 
When changes were actually noticeable as definite 
innovations, they were invariably resisted and only 
succeeded by their inherent advantages gradually 
overcoming the reluctance of the people to change. 
The higher the civilization, the less reluctance is there 
to a change which promises an improvement. At the 
present time in all advanced countries, changes in 
organization and in methods of production have ceased 
to be accidental and are consciously adopted and even 
sought. I 

Modern Civilization Dynamic — The older civiliza-" 
tions conceived themselves as static. In other words 
they believed implicitly that they were the final word. 
We realize now that our civilization is dynamic. That 
is, we know that we cannot stand still. All change is 
not improvement, but there cannot be improvement 
without change. We are not satisfied with our lives. 
We wish constantly to improve them and are con- 
stantly seeking the best means by which an improve- 
ment can be made. 

This is seen in the amazing number of inventions 
which are daily patented in the principal countries of 
the world and particularly in America. No sooner 



I 



THE THEORY OF ECONOMIC DEVELOPMENT 23 

is a machine invented than attempts are made to 
improve it. All those industries which have been 
formerly carried out by individual skill are being as 
far as possible reduced to a routine of motion, with a 
view to the supplanting of human effort by machinery. 
Take the art of printing, for example. Originally the 
type blocks were cut by hand. Now they are cast 
from molds. Originally they were set up by hand. 
Now they are set up by means of the linotype or the 
monotype machine. We use electrotypes where for- 
merly we used hand engravings. We fold the paper 
and bind it by machinery instead of by hand. 

Sufficient has now been said to illustrate the method 
of development. We must now ask whither is the 
development leading, or what is the object at which 
all this progress aims ? 

Growth of Civilization Accompanied by Increase in 
Needs of Man — The advance of civilization is an ad- 
vance in the needs of man. The more highly civilized 
he is, the greater is the number of his wants. Primitive 
man had few requirements and had a great struggle to 
satisfy these. Modern man has a bewildering number 
of wants and the possibility of satisfying these wants 
is much greater than the possibility of satisfying the 
few necessities of the savage. 

Physical and Conventional Necessities — The neces- 
sities of the savage are physical necessities. Without 
them he dies. The man of to-day has many wants 
which he considers as necessities, but which are not 
essential to existence. Life and existence were to the 
savage synonymous terms. They are not so now. We 
realize more and more fully that man does not live by 



24 AN INTRODUCTION TO ECONOMICS 

bread alone. There are " longings, yearnings, striv- 
ings " which must be satisfied. After all, man is a 
social animal. He is interested not only in himself 
but in his neighbors and in his surroundings. Mental 
and social development can only be secured by a certain 
amount of leisure, a leisure which is impossible when all 
efforts must be devoted to wringing from a niggardly 
nature the bare means of subsistence. Hence any- 
thing which tends to subdue nature, to gain a greater 
product with a smaller expenditure of effort, tends to 
increase the amount of leisure which can be devoted 
to the production of those things which contribute to 
mental, social, and emotional development. 

The love of knowledge must be fostered, not for the 
sake of knowledge itself, but because each increase in 
knowledge gives a greater command over nature and 
a consequent increase in the satisfaction that man ob- 
tains from life. In a struggle for existence there is no 
place for beauty ; everything must be sacrificed to the 
production of necessities. But in a full life, beauty 
and art must have their place. A house must no 
longer be a mere shelter, but a place with a beauty of 
its own, a delight to the eye as well as a protection 
from the elements. Music and literature are neces- 
sities when the demands of the purely physical being 
have been satisfied. Life consists more largely in the 
exchange of thoughts, the influence of mind upon mind, 
than we are sometimes inclined to believe. There 
must be free provision for the communion of man with 
man. In short, our " progress " is the growth of success 
in developing the physical and mental man to the fullest 
possible extent. 



I 



THE THEORY OF ECONOMIC DEVELOPMENT 25 

The Economic Problem — The problem which con- 
fronts man, then, is this : Given a world whose re- 
sources are infinite but not all discovered, how to make 
use of the known resources and discover the unknown, 
so that each may satisfy his desires to the fullest extent 
without infringing upon those of his neighbors, and 
without waste. 

To say that this problem is solved is to say that per- 
fection has been achieved and the millennium is at 
hand. What we have to do in our succeeding study 
is to examine how far we have succeeded, and, in so 
far as we have failed, to see why we have failed and how 
the failure may be remedied. 



CHAPTER III 

THE COMPETITIVE SYSTEM 

In the last chapter we stated the problem which the 
world has to solve — the provision of the necessities 
and conveniences of life in as full and free a manner as 
possible to all its inhabitants, and without waste. 
To say that this problem is absolutely solved is, of 
course, untrue. But nevertheless the necessities and 
conveniences are actually produced, perhaps not so 
economically or so fully as is possible, and certainly 
not without very great inequalities in distribution. 

The existing system of production and distribution 
is extremely complex. Indeed it would seem at first 
glance that there is no system at all, but merely a more 
or less haphazard production which results in a certain 
degree of efficiency. As a matter of fact the methods 
of production and distribution at the present time do 
not represent a conscious organization of the means of 
production. They represent rather a gradual growth 
and development from past times, helped here and there 
by conscious attempts at remedying the structure of 
the system as it broke down from time to time. 

Still there seem to be certain principles which have 
governed what arrangement there was in the different 
periods of growth, and in the present chapter we shall 
try to see if there are any which can be said to control 
our present system. 

26 



THE COMPETITIVE SYSTEM 27 

Economic Freedom — The keynote to modern eco- 
nomic life is found in the idea of economic freedom. 
The phrase must be carefully explained, however, 
for the idea involved is a direct revolution from that 
which governed our organization a century ago. In 
the older society which preceded ours it was believed 
that each individual had his place. It was the duty of 
the group to care for the individual and the individual 
was responsible to the group. This idea may be 
illustrated by the gild system, about which more will 
be said later. The trade gild regulated the work 
which each member was to perform and the remuner- 
ation he was to receive. The style and quality of the 
work was controlled to a very large extent and the 
amount allotted to each member was arranged so that 
the work should be divided as evenly as possible. In 
case of the death of a breadwinner of a family, the gild 
looked after the widow and provided for the care of the 
children until they were old enough to enter the gild 
and earn their own living. 

When the gild system decayed and finally broke 
down, the idea of a regulated industry did not dis- 
appear, but rather was emphasized by governmental 
action. Government controlled all industry by stipu- 
lating, for instance, what industries should be carried 
on and how they should be conducted. Industries 
regarded as of national importance were encouraged 
by the offer of bounties on the production of those 
industries or by prohibiting the import of products of 
competing industries in other countries. Inspectors 
were appointed to examine the products of the indus- 
tries to see that they were up to standard. Inspectors 



28 AN INTRODUCTION TO ECONOMICS 

in the wool trade, for example, enforced the govern- 
mental prohibition of mixtures in wools. The cloth 
must be of one grade of wool alone. It must be of a 
certain width and the bolt a certain length. The very 
dyes must be of standard quality and color. 

Regulation of Industry — Industries regarded as un- 
suitable for the country were prohibited. In a word, 
regulation was the main idea in industry. There was 
not an occupation which in some way or other was not 
subject to interference by the government. 

When industry was revolutionized by the great 
inventions of the latter part of the eighteenth and the 
beginning of the nineteenth centuries, manufacturers 
became more and more resentful of the control exer- 
cised by government. They demanded the right to 
make what products they chose and in the way they 
chose. They asked that workmen should be allowed 
to change their occupation as frequently as they wished 
and to move from place to place at will. They did not 
ask for bounties to produce their wares. They believed 
that they had sufficient incentive to production in the 
profits to be derived from the manufacture and sale of 
the goods. 

Production for Profit Most Satisfactory System — 
In short they believed that the individual understood 
his own business a great deal better than any possible 
government, and a theory was developed to justify 
their ideas. It is this theory which we must now 
examine. 

At its basis is the belief that the fundamental 
incentive to all industry is the acquisition of property. 
It was thought that a man would not work unless he 



THE COMPETITIVE SYSTEM 29 

were to receive for his own use the fruits of his industry. 
The greater wealth to be achieved in an industry, the 
more assiduously would the workers in that industry 
labor. Conversely, if there were no profit to be reaped, 
the industry would languish and finally disappear. 
The two propositions were sufficiently well illustrated 
to give an apparent justification to the idea. In the 
manufacturing business, notably the textile industries, 
great profits were possible. These industries developed 
rapidly from being carried on in private homes as a 
part-time occupation, with agriculture as a mainstay, 
to the manufacture in huge factories, with agriculture 
as a separate industry. The converse was illustrated, 
for example, in the Irish rack-renting system. In this 
system the farm lands were rented by a species of 
auction. The landowner offered his land to the farmer 
who agreed to pay the highest rent. In actual opera- 
tion rents were offered infinitely in excess of the total 
possible production of the land. Naturally the farmer 
when he obtained the land was not able to gain sufficient 
to pay the rent, and consequently he immediately 
began to fall into arrears with his payments. The 
arrears mounted with each month of his occupation and 
hence no increase in the harvest v^^as sufficient to do 
more than wipe out a portion of the arrears of rent. 
If the farmer tried newer methods, or spent money on 
manures or on additional labor, he reaped no reward, 
for the increase in the product went directly to the 
landlord. There was no stimulus to increased pro- 
duction, therefore, and with the knowledge that he 
could never secure more for himself than a bare sub- 
sistence, the farmer sought no more than that. His 



30 AN INTRODUCTION TO ECONOMICS 

cultivation was slight and he made no attempts at 
improvement. The Irish farming became perhaps the 
worst in Europe, simply because of the withdrawal of 
the property stimulus. 

The contention that this property stimulus was 
essential would seem to be proved, but at present we 
are not concerned with a more careful examination. 
Later on we shall see that there are other considerations 
to be taken into account. For the present we shall 
admit the contention for the sake of the argument. 

The next point to be considered is the effect of this 
indiscriminate production on the general welfare of the 
community. Would the whole of the needs of the 
community be satisfied if each individual were left 
to himself to produce what he wished, how and where 
he Hked? Would there be greater production in va- 
riety and extent if governmental control were re- 
moved.? These were considerations which had to be 
dealt with. 

Basis of Argument in Favor of Production for Profit — 
Now we are not deahng with a primitive state, but with 
an economic system which had reached a high degree of 
speciaHzation. Each man produced only a small part 
of his own total needs and relied for the satisfaction of 
his wants by exchanging his own surplus product for 
the surplus of others. Naturally each individual 
wanted to get as much as possible for his surplus, and 
his gain therefore depended upon the demand which 
existed for the particular product which he had to 
exchange. If, for instance, a man was engaged in 
producing knitting needles, he could only exchange 
those needles to people who required them. If very 



THE COMPETITIVE SYSTEM 31 

few people wanted knitting needles, then he would 
probably be left with a supply on his hands and he 
would find little profit in the undertaking. If he were 
producing wheat, on the other hand, there was bound 
to be a great number of people who wished to ex- 
change their products for the result of his harvesting. 
Hence he would be able to exchange the great bulk of 
his surplus comparatively easily. 

Now the natural result of this method of production 
would be that each individual in deciding his occupation 
would look for some industry which would produce 
something for which there was a great demand. Few 
people would produce knitting needles and many 
would produce wheat so that the demand for wheat, 
which is general, would be satisfied simply because the 
very extent of the demand would encourage a great 
number to engage in farming. Similarly the demand 
for clothes would encourage a great production of 
clothing materials, whereas the small demand for, 
let us say, picture frames, would only attract a small 
number of producers. 

Even if we admit this argument, however, there 
would appear to be a danger that while the general 
necessities would receive plenty of attention from 
producers, the less essential but still desirable goods 
would be neglected. 

Limitation to Demand for Necessities — The demand 
even for necessities, however, is not unlimited. There 
comes a time when the demand for food, even, slackens. 
If every one is engaged in producing food, there will 
only be food produced and consequently there will be 
no production of clothing or other goods. How is the 



32 AN INTRODUCTION TO ECONOMICS 

proper relation between the production of different 
requirements to be met? 

The Idea of Competition — Let us suppose that a 
given individual is engaged in producing wheat. He 
finds after a time that there is a great deal of other 
wheat, besides his, in the market. If the total amount 
is still insufficient for the needs of the community, he 
can still reap all he requires in the way of exchange for 
his surplus. But if the amount is greater than is 
required, then he must tempt buyers to buy his own 
particular portion. To do this, he must reduce his 
price. But he is not the only one who has wheat for 
sale. Others also are tempting buyers by reductions 
in price. If the supply of wheat continues in excess 
of the requirements of the buyers, the price will steadily 
fall. A time will come when the price is reduced to a 
point where the sales will not provide sufficient for his 
own needs. In other words, his profit will disappear. 
All wheat sellers' profit is not the same. Some have 
better farms tKan others ; some are nearer the market 
than others, or have some special advantage. Hence 
some of the wheat producers can afford to take a 
smaller price than others and still make a profit. 
In the case of the individual with whom we are deahng, 
we will suppose that the point of vanished profits is 
reached. It does not pay him any longer to produce 
wheat. He, therefore, turns his attention to some 
other industry where there appears to be chance of a 
greater profit. 

The results of this change are twofold. First, there 
is a f aUing off in the production of wheat. This is as it 
should be, for it was evident that the supply of wheat 



THE COMPETITIVE SYSTEM 33 

was too great for the market. There will be other 
producers in the same position as the individual we have 
been considering, so the fall in production will amount 
to that portion of the wheat supply which was produced 
by those who are now relinquishing farming. The 
result will be that the others who still continue the 
production of wheat will be enabled to gain a price 
for their product sufficient to repay them for the 
trouble and expense of producing it. 

Second, there will be an increase in the production 
of some other article, the price of which had formerly 
been high. This is naturally the case, since those who 
have given up farming will tend to choose that occupa- 
tion which offers the greatest returns. The fact that 
they so choose, however, means, as we have said, an 
increase in the production of that article, and conse- 
quently the buyers will have a larger supply to satisfy 
their needs. As this supply increases, the producers 
will bid against each other for the custom of the buyers 
and there will, therefore, occur a fall in price. 

Meaning of Competition — It must be noted that 
the competition which exists is between producers of 
the same article and between buyers of that article. 
The producers compete with each other when the supply 
is large by reducing their prices, and so encouraging 
buyers to satisfy their requirements from him who 
offers the cheapest rate. When the supply is small, 
on the other hand, the buyers compete with each other 
by offering increased prices, and so lead the producers 
to sell to him who offers the highest price. No com- 
petition occurs between producer or seller and buyer. 
They are in quite different categories. 



34 AN INTRODUCTION TO ECONOMICS 

Labor Viewed as a Commodity — Now let us 
consider this system from another point of view. How 
does competition affect the relations between employer 
and employee? For the moment we may consider 
labor as being a commodity just as wheat is. Later 
on we shall find that labor cannot be so treated entirely, 
but in the meantime the supposition will not affect 
our argument. If the supply of laborers is large, then 
there will be a tendency for the laborers to compete 
with each other for the existing jobs. Each looking 
after his own interests will offer to work for a smaller 
wage in order to obtain employment. If the supply 
of labor should be small and less than the demand for 
laborers, then the employers will compete with one 
another for the laborers by offering higher wages. It 
should be noticed here, again, that there is no com- 
petition between laborer and employer. There is 
competition between workman and workman, and again 
between employer and employer. 

Claims Made for the Competitive System — It is 
claimed for this system that a natural equihbrium will 
be reached in which ultimately the price of all goods 
offered for sale will be sufficient to remunerate the 
producer fairly, neither giving him too high a profit nor 
too small a return ; there will also be an equilibrium of 
wages so that each laborer will obtain a sufficient sum 
to keep him according to the existing standard of living. 
It is further claimed that all the needs of society will be 
satisfied in exactly the right degree, according to their 
intensity. That is to say, those goods which are 
absolutely essential in large quantities will attract 
the greatest number of producers and those which 



r 



THE COMPETITIVE SYSTEM 35 



are desirable but not necessary will attract compara- 
tively few. 

The system which we have described is known as the 
competitive system. The main belief which lies behind 
such an economic organization, or rather lack of 
organization, is that each individual looks after his 
own interests and in so doing the needs of society are 
best met ; that if the natural selfishness of the individual 
is allowed full play, the results to the community will 
be better than if the governmental organization 
attempts to regulate production. The system is 
sometimes referred to as the laissez faire method. 
The phrase arose from the expression of some French 
economists, that each should be allowed to make 
{laissez faire) what he pleased and allowed to go {laissez 
oiler) where he wished. 

Some Defects of the Competitive System — Now it 
will be at once recognized that the description given 
above is not a satisfactory account of our present 
organization. There are many modifications which 
must be made. In the first place, it is assumed that 
each individual is a capable judge of his own interests 
and also of equal strength in the struggle. This is 
obviously not the case. In the early days of the 
industrial revolution it was soon seen that the weaker 
members of society were driven to the wall. The 
wages of the father being reduced, instead of the 
father seeking new employment in some other industry, 
the labor of the children was called in to assist. Chil- 
dren were set to work at as early an age as four years. 
Hours of labor were extended to an almost unbelievable 
degree. It was not uncommon for children five, six, 



36 AN INTRODUCTION TO ECONOMICS 

or seven years of age to work for sixteen hours a day. 
Women's labor was also abused. We do not now» 
hear of women working as beasts of burden in the 
coal mines. 

Nor was the system satisfactory apart altogether 
from the position of the laborer. In the manufacturing : 
world also the system failed to a very large degree. 
A factory requires a considerable amount of capital 
before it can be put in operation. If prices are so low 
that profits disappear, the capital invested in the 
business is to a very large extent lost. A cotton factory 
cannot be turned into an engineering plant. It may 
easily happen, for example, that many factories are 
working close to the level at which profits vanish. If 
prices continue to fall, not one factory, but many, 
must close, and instead of production being reduced 
merely to a natural level, the production will almost 
cease only to increase to an undue extent when the 
swollen markets are exhausted. 

Failure of Competition — The results of free com- 
petition were seen best in the early part of the nine- 
teenth century. Laborers were badly abused. Em- 
ployment fluctuated rapidly between overwork and 
no work at all. Profits also alternated between high 
rates and the vanishing point. Waste of capital and 
effort was the keynote to the system. Very soon it was 
seen that competition did not pay. Manufacturers 
made agreements among themselves to keep prices up, 
and to keep costs (principally considered to be made 
up of wage costs) down. Workmen endeavored to 
do the same and keep wages up by combinations 
amongst themselves. In other words, it was realized 



p THE COMPETITIVE SYSTEM 37 

with more or less clearness that the individual could 
not look after himself ; he was forced to associate with 
others. 

Nor did people find that governmental control or 
other alleviation of the evils of the system could be 
done away with. Private charity helped in a very 
slight degree to remove the worst of the abuses resulting 
from an unbridled individualism. Natural feelings of 
sympathy revolted at the treatment of babies in 
factories and domestic workshops. The government 
was forced to institute or amend systems of poor relief 
and to restrict the free action of individuals in the 
conduct of their work. Factory acts and education 
acts were passed to insure an improvement in the 
treatment of workers. The acts limited hours of 
labor, first for children and then for women, and 
finally for men. They secured healthier conditions of 
work and better protection from dangerous machinery, 
and so forth. 

Change in Principle of Government Regulation — 
In the main, however, there was a distinct change from 
the form of governmental regulation of industry from 
the older times. Instead of regulating the nature of 
the product, government turned its attention to the 
manner of production. There was still freedom to 
produce what a person wished, although there is a 
strong tendency for the government at present to 
prohibit trades which are considered to be harmful to 
the community. 

This did not mean that the idea of economic freedom 
was abandoned. It only meant a better interpretation 
of the word freedom. Freedom can only exist accom- 



38 AN INTRODUCTION TO ECONOMICS 

panied with restraint. We do not consider the laws 
against murder and theft to be breaches of our freedom. 
We reaHze, on the contrary, that without such laws 
we could not be free. Freedom means the right to do 
as one pleases only so far as the exercise of that right 
does not infringe upon the equal right of our neighbors. 
This is true economically as well as generally. It is 
not true freedom to permit one individual who happens 
to possess certain peculiar advantages to impose his 
will on all others. Government exists to take care of 
the welfare of the community, and if it should occur 
that the welfare of a few individuals is secured at the 
expense of the rest, government must intervene to 
protect the majority. 

Experience has taught us that pure competition 
does not lead to the best results in solving the world 
problem. The system we now live under shows that 
there is a definite, if gradual, elimination of the element 
of competition and a substitution of cooperation. The 
cooperation is not scientifically ordered as yet, however, 
and it tends to show itself in the organization of laborers 
into trade unions for the purpose of collective bargain- 
ing, and of employers into associations tending toward 
monopoly. 

Siimmary — We may sum up the description of the 
modern economic system by saying that it is one of 
modified and controlled competition. The argument 
may be summarized thus : 

1. The wants of society are best met by leaving to the 
individual the complete right to produce what he will. 

2. In so doing, competition will regulate the production in 
such a manner as to secure that all the wants of society are 



THE COMPETITIVE SYSTEM 39 

attended to in the proportion which they are desired, pro- 
vided, however, 

3. That the competition be restrained by various modify- 
ing factors, as, for instance, 

(a) The institution of private charity; 

(6) The institution of governmental charity in the form of 
poor reUef, pubhc hospitals, etc. ; 

(c) The protection of the weak (particularly women and 
children) by governmental regulation of the conditions of 
v/orking ; 

(d) Associations of workmen or employers for the mutual 
protection of interests ; 

(e) Government ownership and operation of industries 
which, from their nature are best operated as monopolies 
(as, for instance, the Post Office) ; 

(/) Government control of industries which have tended to 
become monopolies (railroads, banks, etc.). 

A fuller account of the system will be developed in 
the succeeding chapters. 



CHAPTER TV 
THE MEANING OF PRODUCTION 

Physical and Conventional Necessities — In the 
past chapters we have spoken frequently of necessities. 
The word has not an absolute meaning, however; it 
is relative. AMiat is a necessity to one person is not 
always such to another. One man's meat is another 
man's poison. If we are to make our study at all 
thorough, we must use every effort to define our terms- 
so that there shall be no misunderstanding. In re- 
gard to the word necessities we may distinguish two 
classes. There are first those requirements which are 
essential to the physical life. We cannot live without 
food anywhere. In most cHmates we cannot five with- 
out clothing and shelter. In regard to all three, how- 
ever, the amount and quality of each vary according 
to conditions. An American would starve on the diet 
of a peasant in India. The American regards certain 
articles of clothing essential which an Indian would 
scorn, although li^'ing in the same chmatic conditions. 
The skin tent or the adobe hut are not adequate to 
the necessities of the white laborer. 

Custom has a great deal to do with the definition of 
necessities. TMiat we are accustomed to, we come to 
regard as being absolutely essential, \^^lat we would 
like to possess, but are not accustomed to, becomes 
luxury. For example, people managed to get to their 

40 



THE MEANING OF PRODUCTION 41 

work by walking in the days before there were street 
cars. A conveyance was a luxury. Now the street 
car is an essential need in any city. To those who are 
accustomed to traveling in underground or overhead 
railways or in surface cars, automobiles are luxuries — 
even extravagances. To the professional classes and 
the moderately w^ell -to-do business man, a " machine " 
is regarded as a necessity. 

As man becomes more civihzed, the number of his 
necessities increases, although there is no change in the 
physical requirements to keep him alive. We may, 
therefore, consider the second class of necessities as 
those which are conventional. That is, those require- 
ments which have come to be regarded as necessities 
because those who so regard them are habituated to 
them, are necessities of convention or of custom only. 
Without them, it does not follow that the race would 
die out, or even the indi^ddual perish. 

Characteristics of Civilization — This does not mean 
that such requirements are any the less necessary be- 
cause they could, at a pinch, be done without. When 
we reach a state of civilization, that very fact is evi- 
dence that we have passed out of the stage when there 
was only a step between existence and death from 
privation. And the higher the civilization, the greater 
is the distance between the bare level of subsistence 
and the actual standard of life. This is illustrated all 
over the world. ^Vherever we find a race which we 
consider high in the scale of development we find a 
fairly high standard of living. Or, to put it in other 
words, the greater is the number of conventional, as 
distinguished from physical, necessities. 



42 AN INTRODUCTION TO ECONOMICS 

Great luxuries existing coineidently with great priva- 
tions does not mean a high civihzation. Because a few 
can satisfy every demand that their nature suggests, 
while the rest Hve in sordid poverty, there is no reason 
to think that there is high development. What we 
must regard is the general standard of life of the ma- 
jority of the people. Luxuries are desirable when they 
can be widely shared. If they are only possible to the 
few at the expense of the necessities of the many, then 
they are to be avoided. This question of the relation 
between luxuries and necessities will be dealt with more 
fully later on. In the meantime, we are more con- 
cerned with the means of satisfying the general neces- 
sities. 

Meaning of the Term Wealth — Our desires are 
satisfied either by the provision of goods or of services, 
or of both. Our wealth consists of the number or 
quantity of goods and services which we can command. 
In our study of economics we shall have occasion to 
use the term wealth very frequently. Like most other 
terms which we shall use, it is capable of many mean- 
ings. Ruskin defines wealth as that which avails 
towards health. This is a good definition from Ruskin's 
point of view. But for the purposes of scientific 
measurement we cannot use such a definition. For 
instance, an abundant supply of air and sunshine un- 
doubtedly tends towards health ; indeed it is essential 
to health. But it is not wealth in the sense in which 
we shall use the word. There is no restriction in the 
supply of either air or sunshine. The possession of 
these by one individual does not in any way restrict 
the satisfaction of the needs of any other. The supply 



THE MEANING OF PRODUCTION 4S 

of air is illimitable. The " gentle rain from heaven '* 
falls alike on the just and the unjust. Such forms of 
wealth as are free to all without restriction do not con- 
cern us. We can only deal, in our present study, with 
those forms which are limited in amount. 

The means by which we can distinguish one form 
from another are simple. We need only ask ourselves 
the question, " Would we be willing to exchange any- 
thing for the particular form of wealth we are con- 
sidering? " For instance, take the case of that form 
of wealth which we have just mentioned — air. Would 
we be willing to offer anything for the air we breathe ? 
In ordinary circumstances we would not. We can 
obtain all we want without the necessity of offering 
anything for it. In certain circumstances it is con- 
ceivable that we would be willing to offer all we pos- 
sessed for air. But those circumstances imply a re- 
striction in the amount of available air — a situation 
like that of the prisoners in the Black Hole of Calcutta, 
for example. This only proves our contention. The 
same is true of water also. If we happen to live by 
the side of a stream of pure water to which we have 
easy access, we will offer nothing in exchange for water. 
But in a city where the water must be pumped and 
led through pipes and perhaps artificially cleansed, we 
are willing to pay a price either to a water company 
or to the municipality. The restriction in the supply 
makes for the possibility of exchanging one form of 
wealth for the other. 

Wealth Comprises Services as well as Material 
Goods — Wealth in the economic sense, therefore, 
consists of those goods and services whose quantity 



44 AN INTRODUCTION TO ECONOMICS 

is limited. It will be noticed that the word goods does 
not stand alone. It is not only material wealth which 
is economic. When we are hungry we satisfy our 
hunger with material wealth in the form of food. When 
we are sick we pay for the services of a doctor. When 
we have trouble with our neighbors we have recourse 
to the services of a lawyer. If we desire to go from 
one city to another we make use of the services of the 
railroad company. 

Utility, Distinguished from Usefulness — In short, 
whatever is necessary to satisfy our desires, whether 
it be in the form of some material article or of some 
service, the supply or availability of which is limited, 
we consider as economic wealth. To constitute wealth, 
therefore, there must be a certain quality of useful- 
ness ; the article, or whatever it be, must satisfy our 
want. We might say that wealth consists of those 
things which are useful and limited in quantity. But 
the word useful has disadvantages. We constantly 
use it with a certain ethical idea in our minds. To 
many people, for example, alcohol as a beverage is the 
very reverse of useful. But it does not, for that reason, 
cease to be economic wealth. It satisfies a desire. 
Whether that desire is one which ought to be satisfied 
is beside the point. The fact is that the desire exists 
and that alcohol satisfies it. And so we find it best to 
avoid the use of the word with the ethical implication 
and choose another — utility. A utility is something 
which satisfies a desire. 

Consumption of Utilities — In the satisfaction of 
our desires we consume utilities. The main process 
of life consists of consumption, the consumption of 



• THE MEANING OF PRODUCTION 45 

utilities. All our efforts are made with the idea of 
consumption either obviously or unconsciously. The 
existence of a desire presupposes the means to satisfy 
that desire. In consuming, we destroy. What is 
destroyed must be again produced for further con- 
sumption. It will seem at first glance that consumption 
does not necessarily produce destruction, if we have in 
mind the definition of utilities which was given above. 
We do not destroy the railroad carriage which takes 
us across the continent, or the street car which takes 
us to business. We do not destroy the doctor who 
eases our pain in sickness, or the lawyer who argues 
our case before the courts. Or at least it would ap- 
pear so. But let us examine the matter a little more 
closely. Does the railroad carriage or the street car 
last forever, even if it meet with no accident '^. Sooner 
or later it is worn out and unfit for the service it has 
previously rendered. In other words, for the purpose 
it was supposed to serve it is destroyed. It has been 
destroyed in the course of satisfying the desires of 
travelers. Each traveler has contributed to that final 
destruction. His individual contribution is, of course, 
infinitesimally small, but nevertheless it has helped to 
destroy the street car. Each journey by each indi- 
vidual, therefore, consumes a portion of the possible 
services which that car can render. Again, in the 
case of the doctor, the small amount of attention that 
our own case involves does not seem to detract from 
the total amount that the doctor can give. But each 
doctor is capable, in his lifetime, of only a limited 
amount of service to mankind. Each person who ac- 
cepts of that service is destroying a portion of the total 



46 AN INTRODUCTION TO ECONOMICS . 

amount. He is not destroying the entire usefulness 
of the doctor, of course. But, then, a man is not de- 
stroying the entire loaf when he eats a piece of bread. 

And so it is, also, with the lawyer. When we ask 
the lawyer to plead our cause before the jury, we ask 
for a certain amount of his time and energy which 
cannot be replaced; we destroy, therefore, so much 
of his service. 

Production Determined by Consumption — It does 
not matter, therefore, whether we consider utilities 
as goods or services ; in consuming them we destroy 
them. But in the destruction of those utilities, our 
desires are satisfied, and that is the end which we had 
in view. It is our desires which lead to the production 
of the means of their satisfaction. All our production 
is determined by our desire to consume something. 
This statement, again, seems to be contradictory to 
the facts of life. Many articles are produced which 
seem in themselves to bring into being the desire to 
consume. Advertisers are often heard to say that 
they create the desire to buy articles. If this be true, 
then the articles must have been produced before the 
desire existed, and it would seem that the production 
preceded the demand for consumption, or, in other 
words, that consumption was determined by produc- 
tion and not vice versa. 

Let us examine their argument. Take the case of 
the invention of the typewriter. Before the type- 
writer was invented every one was content to do all 
his correspondence by hand. No writer worried about 
machines for writing. There was a definite demand 
for the production of the writing instruments then 



THE MEANING OF PRODUCTION 47 

known, the pen and pencil, for example. No one knew 
of the typewriter and hence there would appear to be 
no desire to " consume " one. When the typewriter 
was invented the inventor or the company which manu- 
factured it had to create a wish on the part of buyers, 
before the machine could be sold. The typewriter 
was manufactured first and then gradually the public 
was led to see its advantages, until, at the present day, 
no company would attempt to carry on its correspond- 
ence without one or more machines. 

Here, it would appear, is a distinct case of produc- 
tion determining consumption. The production ap- 
peared first and the desire to consume followed. But 
is this actually so .? Was there ever a time when writers 
were perfectly satisfied with their instruments ? Were 
they not always more or less dissatisfied with their 
tools .f* The dissatisfaction may have been more or 
less unconscious, but it was there. It was the in- 
ventor who realized that there was this dissatisfaction 
and who sought a means whereby it might be removed. 
In other words, if the inventor had not believed that 
the desire for a more perfect writing instrument existed, 
he would never have devoted his labor to the design- 
ing of some such instrument. If he had thought that 
no one would buy the typewriter when he had perfected 
it, he would not have invented one. The cause of his 
invention, therefore, was the belief that there was a 
latent desire to " consume " the machine which he 
could design. It appears therefore that the contention 
that consumption in this case was determined by pro- 
duction is only justified by superficial reasoning. Con- 
sumption had determined the production of the in- 



48 AN INTRODUCTION TO ECONOMICS 

stniment and the only obscuring feature was the fact 
that the desire was latent and not obvious. 

For a further proof of the argument that consumption 
determines production, we may consider the case of an 
invention which does not satisfy a latent demand. 
Suppose, for instance, some inventor produced a ma- 
chine for the purpose of tying boot-laces. He might 
manufacture the machine in great quantities, but the 
sales would never justify the manufacture, because 
the demand for such a machine does not exist. There 
would be no desire to consume. In this case, which 
is by no means uncommon, the inventor has made a 
mistake in believing that there was a latent demand 
for his product. Hence his production is a failure. 
It will cease before he has manufactured many ma- 
chines. 

Successful inventions depend upon a correct realiza- 
tion of a latent or obvious desire to consume these 
inventions as much as upon the satisfactory working 
of 'the invention in supplying the demand. Our desires 
to consume articles which as yet do not exist are in- 
finite. It rests with the discoverers and inventors to 
find these desires and to discover a means whereby 
they may be satisfied. And so we find our original 
view, that production is determined by consumption, 
to be correct. 

Definition of Production — So far we have used 
the word "production without defining it. It is now 
necessary that we make clear what it is that we mean 
exactly by the term. In common use there is a limita- 
tion to the meaning of the term "production which does 
not exist in its economic use. An old Irish furniture 



THE MEANING OF PRODUCTION 49 

manufacturer used to say, whenever lie hired a new 
bookkeeper, " Another non-producer on the pay- 
rolL" He, in common with many other people, be- 
lieved that the only actual producers were tho#e who 
were concerned in the actual handling of the materials 
of the finished product. The bookkeeper probably 
never saw the goods until they were finished and ready 
for the market; indeed, in some instances, it would 
be true to say that the bookkeeper never saw the 
finished product at all. How then could he be called 
anything but a " non-producer " ? 

Sometimes a still more restricted meaning has been 
attached to the word 'production. It has been sup- 
posed that only those who are engaged in the actual 
extraction of the product from mother earth are the 
real producers. The farmer and the miner, the hunter 
and the fisherman, would then appear to be producers, 
while the miller and the steel manufacturer, the butcher 
and the fish dealer, were merely " distributors." 

The Miner as a Producer — This contention also 
fails upon close examination. Let us consider the 
case of the miner, for example. Nature provides the 
mineral. The miner extracts that mineral from the 
earth. He does not create it. All that he does is to 
change its place. In the earth it is useless. There 
are vast mountains of iron ore in various parts of the 
world which are, at present, of no value. Intrinsically 
they are just as valuable as the iron deposits near 
Pittsburgh. But the fact remains that the Pittsburgh 
deposits are worked and the others are not. The 
miners have removed the deposits to a place, i.e., the 
surface of the earth, where they may be of service. 



50 AN INTRODUCTION TO ECONOMICS 

But let us suppose that the miner leaves the ore in 
a dump at the mouth of the mine. Is it of any value 
there? Obviously it is not. If the mineral should 
be coal, it must be taken to some place where it can 
be burned and the heat-value obtained. If it is iron, 
it must be smelted. We must therefore add to the 
producers those individuals who remove the ore from 
the surface of the mine to the place where it can be 
used, or who smelt the ore to obtain the pure metal. 

The Steel Manufacturer — Continuing with our ex- 
ample of the iron ore, we have now two classes of pro- 
ducers, the miners who dig the ore out of the mountain 
side and the smelters who obtain the pure metal. Of 
what value, untouched, is the pure iron? It is ob- 
viously unavailable for general use, say for the making 
of steel rails, or of cutlery, until it has been transformed 
by various processes into steel. And the steel itself 
must be again transformed into rails and knives, or 
rolled into plates, or any of the infinite variety of forms 
in which we desire the steel to be changed. Our true 
producers, therefore, consist now of the miner, the 
smelter, the steel manufacturer, the maker of rails, of 
cutlery, of steel plates, and so forth. 

The " Production " of a Ship — Now go a step further. 
This time we will work backward. Let us consider 
the case of that product known as a steel ship. As 
a finished product it consists of the work of a great 
variety of trades and of a great number of different 
materials. Take the materials first. We shall con- 
sider only two, the steel and the wood, although of 
metals alone, zinc, copper, aluminum, brass, bronze, 
tin, and many others are used. We must have first 



THE MEANING- OF PRODUCTION 51 

the ore, produced by the miner. The ore must be re- 
m^oved from the mine by the railroad employee. The 
smelter changes the ore into metal. The cast-iron 
pigs are then transformed into steel which is cut and 
rolled into many forms. It is shaped and punched 
again for riveting. The individual pieces are asseinbled 
by an army of other workers. 

The wood is hewn in the forest, transported by river 
or road to the mill, where it is cut into various shapes 
and sizes. It is further shaped and erected by the ship 
carpenters. Now, it is quite unnecessary to enumerate 
the variety of functions performed by the trades con- 
cerned in the building of the ships. It will readily be 
conceded now that the steel manufacturer is as much 
a producer as the miner, and the shipwright as es- 
sential to production as the railroad engineer. They 
are, then, all producers. But what have they done 
to earn the title ? The miner has changed the location 
of the ore. The smelter has changed the form of the 
ore. The railroad has changed the location of the 
materials. The shipwrights have also changed the 
location of the materials by erecting them into a hull. 

To put it quite briefly, each of these " producers " 
has changed something either in form or shape or situa- 
tion. He has created nothing. 

Agriculture as Production — Again, take the case of 
the farmer; he creates nothing. Nature provides 
for the creation. The farmer merely assists nature in 
changing forms. Carbon, hydrogen, nitrogen exist al- 
ready in various forms and in various groupings. The 
farmer assists in changing the forms and rearranging 
the groupings in such a way that the elements may be 



52 AN INTRODUCTION TO ECONOMICS 

finally consumed by man. The miller does not create 
flour. He merely changes the form of the wheat. 
The flour existed already in the grain. The miller 
extracts it from the grain and removes the husks so 
that the flour may be suitable for baking. The rail- 
road conveys the flour from the place where it is of no 
value for consumption to the place where it can be 
consumed. All those who contribute in any way 
toward preparing the elementary substance for its 
final form and bringing that final form to the place 
where it may be consumed must be termed producers. 

In no case has any material been created. What 
has been created at each stage of production is a new 
utility, a utility of form, of shape, or of place. 

Production of Utilities — Now this puts a different 
complexion on the argument as to who is a producer. 
We have seen that there is no production of actual 
materials. But there is a production or creation of 
utilities. Any one, then, who contributes to the final 
form of consumable wealth by producing some utility 
is a producer. 

How does this affect the old Irishman's argument 
that a bookkeeper is not a producer? What utility, 
if an}'', does the bookkeeper add which is necessary for 
the final product? If the furniture manufacturer, or 
any other manufacturer for that matter, desires to 
keep turning out his goods, he must maintain some 
record of the materials which pass through his hands, 
of the amount due to his laborers, of the amounts paid 
to those from whom he buys goods, and of the amounts 
received from those to whom he sells the goods. With- 
out such records his manufacture would, in practice, 



THE MEANING OF PRODUCTION 53 

be impossible. The bookkeeper, therefore, in making 
those records is adding a utiHty which is absohitely 
necessary. He is as much a producer as any of the 
others. They merely produce utilities — not ma- 
terials, and the bookkeeper does as much. 

It matters not what industry or business is taken, 
the same result will be found. There is no production 
of materials, but a vast amount of production of utili- 
ties. And so we may say that the train dispatcher 
is as much a producer as the locomotive engineer or the 
conductor; the rate clerk as much a producer as the 
track layer, or the engineer who designed the system 
or built the bridges. They all contribute in one way 
or another toward the production of the final utility, 
a transportation system. The student can elaborate 
this for himself and so convince himself of the truth of 
the argument. But it will be advisable to carry our 
illustrations a little further still. In what way are we 
to regard our doctors, lawyers, preachers, artists, 
musicians, and so forth? Do they produce anything.'* 
In our opening argument it was shown that consump- 
tion consisted not of the destruction of materials only, 
but of utilities. These utilities comprised materials 
and services. Services which are not required will 
soon cease to be offered. If we have with us doctors 
and musicians and preachers, it is because these are 
desired. The doctors and the preachers and the others 
are doing no less than the farmers and the miners. 
They are producing utilities, and hence they are just 
as much entitled to the term producer. 

Summary — We may now sum up the argument 
contained in this chapter as follows : 



I 



54 AN INTRODUCTION TO ECONOMICS 

Economic wealth consists of those goods and services which 
are desired but the supply of which is limited. We can 
group both goods and services under the title of "utilities," 
distinguishing the term from the idea of usefulness by the 
elimination of all ethical interpretation. 

Utilities exist or are produced for the sake of consumption. 
Consumption means the destruction of utilities. 

The production of utilities is determined by the consump- 
tion, in spite of an appearance to the contrary. No pro- 
duction will be successful and continuous unless there is a 
desire to consume. 

Just as consumption means consumption of utilities, and 
not merely of materials, so production means the production 
of utilities. In fact there is no such thing as the production 
of materials, in the sense of creation. Form, shape, and lo- 
cation of materials are changed by the creation of utilities. 

Hence those individuals who assist in the creation of new 
utilities must be termed producers. 



CHAPTER V 
THE AGENTS OF PRODUCTION 

From the argument in the previous chapter it will 
be seen that there are two essential requisites for all 
production. First there are material requisites, the 
gifts of nature ; and second, there is the labor which is 
applied to these gifts of nature in order to make them 
available for consumption. 

Meaning of the Word Land, as an Agent of Pro- 
duction — These two requisites are usually termed 
the agents of production. The first of the two is com- 
monly summed up under the term land. It is very 
important to remember, however, that the word 
land is used in a sense very different from the 
ordinary meaning. It includes not only the dry land, 
but also all those other gifts of nature which furnish 
man with the raw material, as it were, of his necessities 
— air, sunshine, rain, heat, and so forth. This wide 
meaning given to a simple and common word will not 
involve us in unusual difficulties. After all, the natural 
forces, unsupported by the addition of directing labor, 
are free to all. They cannot be considered as economic 
wealth. And we shall, therefore, tacitly ignore all 
but the material meaning when we use the word. Land, 
then, for our purposes, will be taken to mean the earth, 
including its contents, in the form of minerals, etc., 
and water with its contents. 

55 



66 AN INTRODUCTION TO ECONOMICS 

Meaning of Labor — The other requisite for pro- 
duction, labor, is equally important. Without labor 
very little is possible in the way of production. In- 
deed, if we regard the plucking of fruit from the tree 
as labor, we may make our statement still stronger 
and say that without labor no production is possible. 
By labor, we mean every effort put forward by man to 
further the satisfaction of his requirements. We are 
not using the word in the sense of manual effort only, 
as it is commonly used. We shall find, later on, that 
when we speak of " labor problems " we are dealing 
with those problems which affect manual laborers 
principally ; but in general, when the term labor is 
used, what is meant is the more general idea of effort 
of mind and hand, in short, all that man does to make 
available for consumption the materials which nature 
supplies. 

These two requisites, then, form the basis of our dis- 
cussion of the agents of production. But labor, in 
itself, is subdivided into two classes. First, there is 
the actual labor which is exerted at any given time 
and to which the term labor is in practice restricted. 
And second, there is what might be termed stored-wp 
labor but which is usually referred to as capital. 

While it is true, to a limited extent, that capital may 
be considered as stored-up labor, the definition is not 
very satisfactory and it will be better to examine the 
meaning a little more closely before we attempt to 
give a formal definition. 

Meaning of Capital — Even in comparatively primi- 
tive times, man usually possesses certain more or less 
elementary tools. That is, he has made instruments 



J 



THE AGENTS OF PRODUCTION 57 

not for the satisfaction that he can obtain from them 
directly, but because by their use he can satisfy his 
ultimate desires more easily or more abundantly. Let 
us examine a simple illustration. A man can obtain 
a drink of water by dipping his face in a stream, or by 
scooping up water in his hand. In this case his " labor " 
is direct. Each action brings an iftimediate consump- 
tion. It is easier and more satisfactory in every way 
to use a cup. But a cup must first be made. The 
labor involved in making a cup is not expended for the 
immediate satisfaction of some desire. It is expended 
for the purpose of facilitating some future labor which 
leads to the ultimate satisfaction of the desire. Sup- 
pose the stream runs some little distance from the 
dwelling of the man. Each time he wants to drink 
or to obtain water for any purpose he must go down 
to the stream, taking his cup with him. If he wishes 
water for cooking, he must go to the stream several 
times, each time bringing back with him some water 
in his cup. A little additional expenditure of inter- 
mediate labor will result in the making of a larger 
vessel, which he may fill with his cup at the stream and 
so save several journeys. Still further, if he spends 
more labor in the intermediate process, he may con- 
struct a runway or pipe leading from the higher levels 
upstream to the lower level of his house and so avoid 
all necessity to visit the stream. With each of these 
tools or appliances, the obtaining of water becomes 
easier and more satisfactory in amount. 

Appliances made for the purposes of facilitating 
production and not for immediate consumption we 
may term capital. Now carry the illustration a little 



58 AN INTRODUCTION TO ECONOMICS 

further. Suppose the man decided to make a pipe. 
He has to expend effort first in discovering some hollow 
trunks of sufficient length to answer his purpose. At 
best the result will be only partially satisfactory. If 
he had an ax or a saw, he would be able to produce a 
much better pipe. He, therefore, spends sufficient 
time and energy tt) make an ax. With the ax he 
cuts down the most suitable piece of lumber and shapes 
it for the pipe he wishes to make. Now we have a still 
further example of the application of labor for inter- 
mediate purposes. The ax is made to shape the pipe. 
The pipe is made to lead the water. Both are pro- 
duced with the idea, not of immediate satisfaction, 
but in order to make the ultimate satisfaction easier 
and more complete. 

This simple illustration of elementary capital may 
be developed to explain the highly complex system of 
modern production. But instead of only one or two 
intermediate stages in production, there are very many. 
For example, take the printing trade. We already 
have miners who are producing steel and zinc and lead. 
They do not wish to use the metals themselves, as the 
ultimate reason for producing them. These metals 
are to be used for the making of printing presses and 
type metal. Lumbermen are felling trees, which are 
turned into wood pulp, and this again is turned into 
paper to be used in the printing presses. The final 
article to be consumed, and for which consumption all 
the preliminary processes have been carried on, is the 
newspaper or book. In each case the intermediate 
product is a form of capital. It is a form of wealth, 
the object of which is not the immediate satisfaction 



THE AGENTS OF PRODUCTION 59 

of some desire, but the facilitating of some other pro- 
duction which has for its aim the ultimate satisfaction 
to the consumer. Wealth which is used to produce 
more wealth we term capital. Wealth which is to be 
consumed we may distinguish as consumer's wealth. 

Capital and Consumer's Wealth — It is often, how- 
ever, very difficult to distinguish between the two, as 
the distinction frequently depends upon the point of 
view. As an example, let us take the position of a man 
who manufactures printing presses. The steel and 
machinery which he uses in turning out the finished 
product is his capital. It is wealth which he uses to 
produce more wealth. His finished product, however, 
is ready to be consumed by the printer. From the 
point of view of the press manufacturer the printing 
press is a finished product, and consequently to be 
regarded as consumer's wealth. But that is not the 
view of the printer. He uses the press to print his 
newspaper or book. The latter is the finished prod- 
uct, the consumer's wealth. To him the printing 
press is capital. 

Again, a real estate owner who has a number of 
houses which he rents is using those houses as his 
capital. They are wealth which is used to produce 
more wealth. He does not consume the houses him- 
self. But the individual owner of a house in which 
he lives is using that house for the final consumption. 
He is getting the ultimate satisfaction out of the house, 
the provision of his shelter from the elemejits and of 
the home comforts which he demands. To him, the 
house is consumer's wealth. 

The distinction between capital and consumer's 



60 AN INTRODUCTION TO ECONOMICS 

wealth, therefore, Hes in the use to which the wealth 
is put. Wherever the particular form of wealth under 
consideration is used as an intermediary in the pro- 
duction of some other wealth, it is capital. ^Vhenever 
it is regarded as satisfying a particular want, it is con- 
sumer's wealth. 

Classification of Forms of Capital — The wealth 
which is classed as capital, however, may itseK be 
classified into several varieties, of which we shall 
mention the two most important. In any manu- 
facturing business we may note that there are two ele- 
ments at least in the enumeration of capital in the 
balance sheet. One of these elements is the plant, 
which consists of the buildings and machinery ; and 
the other is the stock of goods on hand. In a furniture 
factory, for example, part of the capital is represented 
by the buildings and by the planing, sawing, and turn- 
ing machines, and so forth, which turn the wood into 
furniture. Another part is the wood which is used 
in the furniture. Now there is an essential difference 
between the two. The wood is the raw material of 
the product. Once it is turned into furniture it is in 
the form for final consumption. That wood can no 
longer be used for production. If the factory is to go 
on producing, there must be a fresh stock of lumber 
obtained. But this is not true of the machinery. The 
machinery can still go on turning out dining-room 
suites as fast as the wood is available. Throughout 
the whole ^ process the planing machine, the jointer, 
or the saw remain the same. The wood changes from 
raw lumber to shaped wood and finally to furniture. 
There is a constant circulation of wood through the 



THE AGENTS OF PRODUCTION 61 

factory, a constant stream of raw wood into the factory, 
and as constant a stream of furniture out of the factory. 

Circulating and Fixed Capital — That portion of 
the capital, then, which circulates through the factory 
is termed circulating capital. In our illustration, the 
wood used, the materials for polishing and staining, 
the hinges and brass work, and so forth, are all circu- 
lating capital. That which is used over and over 
again, which performs the same functions until broken 
down or worn out, is called fixed capital. 

In the modern organization of industry the out- 
standing feature is the great amount and importance 
of fixed capital. It is largely because of the importance 
of this fixed capital that we speak, sometimes, of the 
present organization as the capitalistic system. 

The further back in history we go, the less important 
becomes the fixed capital in any industry. It is not 
so very long ago that our ancestors obtained their 
cloth from a hand-loom, woven from thread spun on a 
spinning wheel. The total cost of both instruments 
represented a few dollars. The modern system in- 
volves an immense expenditure in the provision of 
large buildings containing a vast number of spindles, 
other buildings with very many looms, and still others 
with dyeing vats, all operated by costly engines to 
supply the motive power. In former times manu- 
facture was literally what the word means, the making 
of things by hand. Now it means the making of 
articles by machinery. 

Division of Labor under Capitalistic System — Ob- 
viously there must be some advantages in the present 
system or it would never have developed. These 



62 AN INTRODUCTION TO ECONOMICS 

advantages are to be sought in the utiHzation of that 
principle which we have already stated to be one of 
the most important elements in economic progress — 
the principle of division of labor. The capitalistic 
system allows a very full development of that principle. 
In former times it was possible for a man to have the 
thread for his clothes spun in his own home, woven into 
cloth, and dyed and turned into suits of clothes with- 
out leaving the dwelling. Now some men (or women) 
spend all their time doing one small operation, neces- 
sary, but not always of obvious importance. One will 
card, or comb out the wool; another will turn the 
wool into rough yarn; a third will change the rough 
yarn into finer thread. The cloth is woven by one set 
of workers, dyed by another. The manufacture of the 
finished cloth itself is a combination of many different 
occupations. 

This statement, however, does not explain why the 
multiplication of occupations is an improvement in 
production. The explanation consists in an elabora- 
tion of two very common sayings. One is the reference 
to a handyman as " a jack-of -all- trades but master of 
none," and the other is the advice to " let the cobbler 
stick to his last." If any individual tries to do all that 
is necessary for himself, he does nothing particularly 
well. We often hear men boasting that they built 
their houses themselves. As a rule they are compli- 
mented with the reservation that the house is a good 
one, considering the inexperience of the workman. 
But it is never admitted by the critics, or, indeed, sug- 
gested by the workman, that the result is as good as 
that produced by the professional builder. When a 



THE AGENTS OF PRODUCTION 63 

man devotes his time to one occupation he usually 
makes a better job than if he divides his attention over 
many trades. His hand and eye become so trained 
that they work to a certain extent automatically. The 
amateur, on the other hand, has to work each detail 
of the operation consciously. Watch a small child 
trying to fasten a button. Each step in the operation 
(and a little consideration will show that there are 
several steps) is performed laboriously and slo\Yly- 
When the child is older, the habitual performance of 
the same operation has brought a skill that is auto- 
matic. The individual movements which are neces- 
sary are correlated unconsciously. Each muscle auto- 
matically performs its function, and the speed is 
infinitely greater than at the beginning. 

This is true of every operation. Habitual per- 
formance of one function, while it may have dis- 
advantages which we shall consider in a later chapter, 
nevertheless results in a great increase of speed and 
efficiency. A combination of experts produces a much 
better-finished article and produces it a great deal 
quicker than is possible for one man performing all 
the operations necessary. 

Hence we have arrived at the stage in our economic 
evolution, when we consciously try to develop new 
additions to our occupations, splitting up the old ones 
into parts, so that each operation consists of fewer 
movements, better coordinated, and all with the view 
of increasing production in quantity and in quality. 

It is partly this increase in specialization which has 
led to the wonderful development of mechanical in- 
vention. The individual motions necessary in the 



64 AN INTRODUCTION TO ECONOMICS 

performance of a given function have been so simplified 
that the possibility of their performance by machinery 
has become more obvious. 

Scientific Labor — There has even been developed 
a science of production which aims at the careful 
analysis of every function in a trade in order to elimi- 
nate waste motion. A skilled mechanic is asked to do 
a piece of work and a moving picture is taken of the 
process. Each movement of hand or arm or head is 
seen in the film, and wherever waste or unnecessary 
motion is apparent, that motion is eliminated. We 
shall have occasion to criticize this method of studying 
production later on. In the meantime, it suffices to 
show the immense importance and value of the division 
of labor. 

Specialization in Location of Industry — One further 
consideration must be noted. Not only is there a 
specialization of occupation in regard to the workers, 
but also there is a specialization of locality. Each 
district tends to be occupied with some form of pro- 
duction for which it is peculiarly suited. The middle 
west is more suited to farming than to manufacture. 
The Pittsburgh region would be wasted if it were de- 
voted to agriculture. This is, of course, only a broad 
division. In agriculture, some districts produce wheat 
and others, cereals ; others grow cotton, others oranges 
and peaches. In some manufacturing districts the 
attention of the manufacturers is almost wholly de- 
voted to the production of automobiles, in others to 
shipbuilding, and so on. The student can easily find 
examples to illustrate this territorial division of labor. 

Industries do not group themselves haphazard. 



THE AGENTS OF PRODUCTION 65 

There is always a reason for their existence in any 
given locaHty. The making of any kind of machin- 
ery depends very largely upon three or four fac- 
tors. First the raw materials must either be present 
or readily available. Then the motive power must 
be there, either in the form of coal within a short dis- 
tance, or else of electric power. There must be a suf- 
ficient supply of labor of the right kind. And there 
must also be ready access to the market for the product. 
Historical considerations also have their bearing upon 
the location of industry. Sheffield cutlery, for ex- 
ample, is famous all over the world. But Sheffield 
has not now what would be regarded as exceptional 
facilities for the production of high-grade cutlery. 
Originally the industry was located at Sheffield be- 
cause of the presence of a certain kind of stone, known 
as Sheffield grit, which was peculiarly suitable for 
grinding. Iron ore was also close at hand. Now the 
cutlery is made from Swedish ore and is ground with 
carborundum, an artificial product. The associations 
of the past have kept up the industry in the present. 
It must always be remembered, however, that his- 
torical associations will not suffice in themselves to 
keep an industry in a certain location. In former times 
iron smelting always took place near a forest, for the 
ore was smelted with charcoal. Now it is situated 
where coal, not wood, is available. The economic con- 
ditions must always be suitable. But given fairly 
satisfactory economic conditions, historic associations 
will keep an industry alive, even though the industry 
would not be attracted there because of peculiar ad- 
vantages. 



JL. 



CHAPTER VI 
THE LAWS OF PRODUCTION 

Much stress lias been laid in previous chapters on the 
importance of the principle of division of labor. The 
whole object of this division, as has already been seen, 
is to make production easier and more economical. 
That is, we have secured, in this principle, a means of 
producing much more rapidly and, very frequently, 
much better, those things which we conceive to be 
necessary for our existence. Now the fact that we 
are living in an age of specialization necessarily means 
that there must be a great deal of exchange of sur- 
pluses. Each produces more of a given kind of wealth 
than he needs for his own consumption, and exchanges 
the surplus for other kinds of wealth produced by his 
neighbors. 

Production Stimulated by Profits — Obviously each 
will attempt to exchange his surplus to the best advan- 
tage; he will try to gain as much by his exchanges 
as possible. The more he obtains by exchanging the 
surplus of his own product the greater will be his satis- 
faction in that production. The less he is able to ob- 
tain by such exchanges, the less will be his desire to 
continue producing that particular article. If, for 
example, a man finds that by producing furniture he 
can exchange his surplus for all the other products that 

66 



THE LAWS OF PRODUCTION 67 

he requires, he is satisfied and goes on manufacturing 
furniture. But if he finds that every one has already 
sufiicient furniture and that consequently he is not 
able to exchange his surplus for more than a small 
fraction of his other needs, then he will cease to con- 
tinue the business and will seek some other article to 
produce which is more in demand. 

His production, therefore, will depend to a large ex- 
tent upon the amount of wealth that he can gain by 
exchange of surplus. This, of course, is not the only 
reason for his production. There are many others. 
He may be satisfied with a small return for his effort 
if, for example, the actual production itself gives him 
a great deal of pleasure. An artist will often keep on 
painting pictures although he could gain much more 
by drawing posters for advertising firms. But these 
other reasons for production will occupy our attention 
in a later chapter. In the meantime we can safely 
regard the desire to exchange wealth produced by the 
individual for other kinds of wealth produced by other 
workers as the main stimulus to production. 

Production Secured through Application of Capital 
and Labor to Natural Resources — Now all production 
is secured by the application of two of the agents 
which we discussed in the last chapter to the third. 
Capital and labor are applied to natural resources, and 
the result is the creation of utilities in a form ready 
for immediate or ultimate consumption. The furni- 
ture manufacturer applies his capital and the labor of 
his workmen and himself to the wood and other ma- 
terials which are provided by nature, and the result 
is shown in tables and chairs and so forth, all ready to 



68 AN INTRODUCTION TO ECONOMICS 

be used by purchasers. The farmer appKes his capital, 
in the form of various kinds of agricultural machinery, 
barns, dairies, etc., and the labor of his men, to the land. 
The result is the production of food for the people. 

Neither the farmer nor the manufacturer is in the 
business "for his health." Each calculates with 
greater or less accuracy the return which he will ob- 
tain for his expenditure of time and capital. And each, I 
in his way, will try so to use that capital and labor as; 
to obtain the greatest return. 

Necessity for a Certain Minimum Capital and Effects ; 
of Increases — Neither, however, will attempt to com- 
mence production without a certain minimum of ' 
capital. If the farmer starts on a large farm without 
sufficient capital, he soon finds that his production is 
too expensive. The returns are not sufficient to justify 
what expenditure he has made. In other words, he 
finds he is working at a loss. His natural remedy is 
to find more capital. We are not concerned here as 
to his methods of finding the additional capital. Find 
it he must, however. And when he has found more 
capital and applied it and the result justifies his efforts, ij 
he immediately wonders whether greater results can 
be obtained by the use of a little more capital or by 
the employment of a few more laborers. The ad- 
ditional expense of irrigating a certain field, for ex- 
ample, may be more than offset by the increased pro- 
duction from that field. An extra hand to help in the 
plowing of another field may mean a larger harvest. 
Of course the irrigating of the field or the employment 
of the laborer will mean more expense. But if the re- 
turns due to that additional expense are considerably 



THE LAWS OF PRODUCTION 69 

greater than the actual expense itself, then the pro- 
cedure is justified. 

Let us take a concrete instance. Suppose a farmer 
has been in the habit of using horses for his plowing. 
With the number of animals he possesses he is able to 
cultivate one half of his land, using the rest for pasture. 
By the addition or substitution of motors he believes 
he could cultivate three quarters of the land. The 
point that he must decide is this. Will the additional 
crop from the extra quarter be of sufficient value to 
pay for the expense of buying and operating the motor 
plows .f^ If so, then he is justified in considering the 
purchase. But it is doubtful whether he would actually 
purchase the motors if he thought that the result would 
only be sufiicient to pay for, and operate, the plows. 
There must be an increased profit to make the actual 
purchase worth while. If by the use of his existing 
means of production he is able to gain an income of say 
$3000 in a year, and the substitution or addition of 
motor plows will produce an income of $3500 and also 
pay the annual proportion of expense of purchasing 
and maintaining the motors, then obviously the motors 
should be bought. 

Again, if he is considering the employment of more 
laborers, he must estimate the amount of . additional 
profit which would result from the addition to his pay 
roll. If that amount is greater than the pay of the 
laborers, then, naturally, it pays him to hire the men. 
If the new profit is only sufficient to pay the wages of 
the new laborers, he is not justified in hiring them. 

The " Dose " of Capital and Labor — Still further, 
it may not be a case of simply a few more laborers, or 



70 AN INTRODUCTION TO ECONOMICS 

some machinery. It is quite possible that both are 
necessary. It is usually the combination of the two 
which must be considered. We can simplify our argu- 
ment, then, by taking some hypothetical addition of 
both capital and labor combined, which we may call 
a dose of capital and labor. We must remember, of 
course, that the idea is arbitrary. There is no such 
thing as a uniform application, but the conception is 
useful for the purpose of argument. 

In commencing any production, then, a certain 
number of doses of capital and labor are essential be- 
fore the production can be profitable. With one dose 
the return would not be sufficient to bring any profit. 
A farmer might conceivably start farming with one 
horse and one plow and the labor of his own hands. 
But he would not make much of a success of the farm. 
The minimum number of doses to be applied must be 
sufficient to bring what may be termed the normal 
'profit. That is, it must be sufficient to bring as much 
profit as its employment in any other industry would 
bring, on the average. To make this quite clear let 
us again consider a concrete example. Suppose, by 
the application of a given number of doses of capital 
and labor, an income of $3000 a year can be obtained 
in many different industries — farming, manufacturing, 
et cetera. Then we may consider that the normal 
return from that number of doses is $3000. Now if 
the application of a further equal number of doses 
only brings an additional $3000, then the addition 
has only secured the normal profit. But if this addi- 
tional application produces a return of, say, $4000, 
it is quite obviously well worth applying. 



I 



THE LAWS OF PRODUCTION 71 

Each individual farmer or manufacturer must con- 
sider for himself when the application of additional 
doses of capital and labor will produce an increase over 
the normal return. There are times when it will and 
other times when it will not, and the occasions will vary 
from industry to industry. 

Let us continue our illustration of the farmer's occu- 
pation. The farmer commences with the minimum 
necessary to secure the normal return. Anything less 
would prevent him from continuing farming. Almost 
invariably he finds that an additional dose brings a 
more than proportionate increase in returns. A further 
dose again brings in additional proportionate increase 
and so on, until a time arrives when the extra increase 
over the normal produced by one more dose of capital 
and labor does not amount to as much as that pro- 
duced by the previous dose, and with each additional 
dose the return above the normal rate falls until at 
last a time is reached when the addition of one more 
dose only produces the bare normal return. 

Law of Increasing Returns — When that time is 
reached, it is time to stop applying any more capital 
and labor to that farm. When it is found in any par- 
ticular industry that an additional dose of capital and 
labor produces a more than proportionate increase in 
return, that industry is said to be subject to the law 
of increasing returns, or increasing productivity. 

So far we have considered the matter from the point 
of view of the farming industry. This is not, how- 
ever, the best illustration of the action of the law oi^ 
increasing returns. Most farms in a highly organized 
community have ceased to be subject to that law. 



72 AN INTRODUCTION TO ECONOMICS 

The normal profit from farming is that represented 
by those farms which are using the most satisfactory 
amount of labor and capital. In the manufacturing 
industries, however, the law is better exemplified. 
Many small factories are at work and continuing pro- 
duction with a fair degree of satisfaction, although 
an increased amount of capital and an addition to the 
number of workmen would produce a proportionately 
greater profit. Every one has heard, at one time or 
another, complaints of small manufacturers, and even 
of larger ones, that they are working at a disadvantage 
from lack of capital. This is only one way of stating 
that their industries are subject to the law of increasing 
returns. The manufacturers imply that if they had 
more capital, or could obtain more laborers, their 
profits would more than justify the additional expense. 
Illustration from Ship-building Industry — At the 
present time a very good example is found in the ship- 
building industry. The demand for ships is very much 
greater than the supply. Plant after plant is hampered 
in its production by the fact that it has to wait for the 
production of machinery — steel punches, drill presses, 
shearing machines, and so forth. All these represent 
capital. If they were able to obtain these machines 
more rapidly, their production would be increased to 
such an extent that the profits reaped would very much 
more than offset the cost of the additional machinery. 
The same is true in respect of labor. The supply is 
not nearly so great as the demand. Many more work- 
men could be employed and the profits from their 
labor would be much more than proportionate to the 
wages paid to them. 



THE LAWS OF PRODUCTION 73 

Law of Diminishing Returns — But even in manu- 
facture there comes a time when the law of increasing 
returns ceases to operate. As the demand for ships, 
for example, is satisfied, there will be less need for the 
production of new ships. The prices for tonnage will 
fall and profits will fall with them. Hence the pro- 
vision of more capital and labor will be less and less 
desirable. Finally it will be undesirable, in that the 
cost of the additional doses will be greater than the 
returns from those doses. In other words, a time comes 
when the reverse law, the law of diminishing returns, 
operates. 

Sooner or later in all industries the law of diminishing 
returns comes into play. In fact, it may be said that 
the operation of the law of increasing returns represents 
a temporary condition only. It works up to a certain 
point and when that point is reached the law of dimin- 
ishing returns takes its place. This latter law, stated 
simply, means that with each additional dose of capital 
and labor applied to an industry, the return is less. 
This use of the word return, however, must not be 
understood to mean the money reward for the pro- 
duction. It means rather that the net amount pro- 
duced is less. For this reason, the law is sometimes 
called the law of diminishing productivity. 

In the case of a farm, for example, if the return from 
one dose of capital and labor represents one hundred 
bushels of wheat and an additional dose only secures 
a return of ninety bushels, then the law of diminishing 
returns is in operation, whereas, if the new return had 
been one hundred and ten bushels, then the other law, 
of increasing returns, would be indicated. 



74 



AN INTRODUCTION TO ECONOMICS 



The law of diminishing returns begins to operate long 
before the point of normal returns is reached. In the 
foregoing example, for instance, it may be supposed 
that a return of fifty bushels for one dose of capital 
and labor would be sufficient to justify the farmer con- 
tinuing his business. If that were the case he would 
not cease to add doses of labor although the return to 
each dose was less with each addition. As long as the 
return was more than fifty bushels he would be willing 
to add dose after dose. But in time there would come 
an additional dose the return for which would only 
be forty-nine bushels. At that stage there would be 
no profit on the increased use of labor and capital, and 
hence there would be a definite cessation of increases. 

Graphic Illustration — Perhaps the whole question 
can be made more distinct by a visual illustration. 



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Curve To lLLUsTRi\Te The. Liwns of Incrcasing 
AND O1MIN1&H1N6 Returns. 



THE LAWS OF PRODUCTION 75 

The application of the laws of increasing and diminish- 
ing returns may be illustrated by means of a curve. 
Figure 1 represents such a curve. Along the line OX 
each division represents one dose of capital and labor. 
Along the line OY each division indicates, let us say, 
ten bushels of wheat. L'et us assume that production 
commences with sufficient capital barely to justify 
its application, and that the return is fifty bushels of 
wheat. Along OF we mark the point B which is five 
spaces from 0. This represents fifty bushels of wheat. 
The first additional dose, let us say, brings a return of 
sixty bushels. From the first division along OX we 
count up six spaces and then mark a point. Now sup- 
pose that the returns for each of the doses of capital 
and labor run as follows : 65, 70, 75, 80, 82, 84, 85, 
84, 82, 80, 75, 70, Q5, 60, 50, 43, 35, 30, 28. In the 
same way as before we mark a point for each additional 
dose indicating the return from that dose. Then we 
join the points and obtain the " curve " BECF. 

This curve represents both the law of increasing 
returns and the law of diminishing returns. The 
highest point reached is that which represents the re- 
turns for the eighth dose. From that time onward 
each dose brings in a less return than the previous one 
and so, obviously, the law of diminishing returns is in 
operation. The curve up to the point E, therefore, rep- 
resents the operation of the law of increasing returns and 
from E onward the law of diminishing returns. 

We have assumed, however, that production is 
justified as long as there is a return of fifty bushels 
from each dose of labor. From the point B, which 
represents a production of fifty bushels, we draw a 



76 AN INTRODUCTION TO ECONOMICS 

horizontal line BC until it reaches the curve at the 
point C. This line represents the line of normal re- 
turns. Any dose of capital and labor is justified whose 
production reaches this line. Hence the total actual 
production will be represented by the area included 
in the figure OB EC A. There will be no further pro- 
duction after the sixteenth dose, because the return 
from the seventeenth is less than fifty bushels. 

The object of all systems of production should 
naturally be to secure such an application of the avail- 
able capital and labor that all industries have reached 
the condition represented by the point E on the dia- 
gram. That is the point where the capital and labor 
have been utilized to the highest advantage. Wherever 
the law of increasing returns is in operation there will 
be a struggle to increase the amount of labor and capital 
appHed to the industry so that the utmost production 
can be secured from the effort applied. 

Effect of the Operation of the Laws of Increasing 
and Diminishing Returns — Whenever in any given 
industry the point is reached where the law of diminish- 
ing returns has been in operation long enough for the 
returns to drop to the minimum required for normal 
profits, then there will be a tendency to divert capital 
and labor from that industry toward some other where 
either the law of increasing returns is in actual opera- 
tion, or where the law of diminishing returns has not 
progressed to the point of normal minimum returns. 

In the following chapter we shall discuss some of the 
methods of industrial organization which have been 
instituted with the idea of making the most economic 
use of capital and labor. 



I 



CHAPTER VII 
THE ORGANIZATION OF PRODUCTION 

From a certain point of view the heading of this 
chapter gives a somewhat wrong impression. Pro- 
duction in our modern world is hardly organized at 
all; it is rather haphazard. But even as we have 
seen that there are underlying laws which give a sense 
of unity to the competitive system, so we may see 
certain rules at work which, while they do not amount 
to a definite organization, nevertheless show that there 
is a certain method at least, which takes something 
from the haphazard appearance. 

Distinction between Business and Industry — In a 
former chapter it was shown that production consisted 
in altering the form, the shape, or the position of wealth 
or in the creation of services. Production may, how- 
ever, be roughly divided into two classes. There is 
that form of production which consists very largely 
in the altering of the form and shape of material wealth, 
and there is the other kind which consists in the dis- 
tributing of the wealth. The common terms. Industry 
and Business, serve to designate the two classes with 
sufficient accuracy for our purpose. Industry is re- 
lated principally to manufacturing and mining, al- 
jthough for the purpose of this rough classification we 
may also include agriculture. Business is concerned 

77 



78 AN INTRODUCTION TO ECONOMICS 

with the exchanging of goods. It is not commonly 
considered as being production, but in the sense in 
which we have defined the term it is as much so as 
any other form of economic activity. Business pro- 
duces utihties, and that is all that is done by the in- 
dustries. 

The further back one moves into the historic past, 
the more hazy becomes the distinction between the 
two classes. Primitive business and manufacture were 
conducted by one and the same individual. The arrow 
maker made his arrows and also attended to the ex- 
change of his product for that of the hunter. But the 
further one moves from primitive methods, the more 
does the principle of division of labor operate. Special- 
ization in the methods of exchange increases as rapidly 
as specialization in the realm of industry. 

Early Trade — There is much that is interesting in 
the history of the development of the merchant class 
and of its methods. The early chapman or peddler 
was a familiar figure in the times when Alfred the 
Great ruled over the Saxon kingdoms in England, and 
Charlemagne built up his great empire. The wander- 
ing merchants from far-off countries were either eagerly 
welcomed or driven off with suspicious hate, according 
to the development of civilization in the lands which 
they visited. 

Merchant Fleets — Essentially, however, in all those 
early examples of business activity, we find merchants 
working almost entirely upon their own capital. They 
bought the goods which they sold. There was no 
commission business done. Hence the amount of 
business done by one particular firm or merchant was 



THE ORGANIZATION OF PRODUCTION 79 

usually small. In order to cope with larger business, 
partnerships were necessary and they developed in 
their own fashion-. Merchant trading, especially in 
oversea traffic, was a hazardous occupation. The seas 
of Europe swarmed with pirates. The single vessel 
owned and often commanded by the merchant whose 
goods it contained, was seldom a match for the swift 
galleys of the pirates. For the sake of protection the 
individual voyage gave place to the voyage of the mer- 
chant fleet. At regular periods the Venetian or 
Genoese fleets left their home ports in the Mediter- 
ranean to sail to the Levant or along the western coasts 
of Europe. But it must be remembered that these 
fleets consisted not of one individual venture. They 
were a unit only in the fact that the ships sailed to- 
gether. Each ship was a separate enterprise. It is 
true, of course, that as trade grew, more than one mer- 
chant was associated with the venture in a particular 
ship. 

Formation of Partnerships and Companies — Tem- 
porary partnerships were arranged where the fortune 
of one merchant was not sufficient to fit out a whole 
ship. And later on as the partnerships grew in size 
perhaps several vessels were required to carry the goods 
of the partners. Still later, it was found that more 
could be done by the combined efforts of large groups 
of merchants whose interests lay in one particular 
trade than by the individuals who composed the groups. 
Companies were formed whose objects were to secure 
treaties from foreign governments and to provide means 
of securing just payments for goods sold in the lands 
which the fleets visited. 



80 AN INTRODUCTION TO ECONOMICS 

Indeed at the ports of call the companies had their 
own " factories " which were not factories at all in 
the modern meaning of the word. They were rather 
storehouses and trading stations. Naturally the group 
of merchants who formed the companies had to have 
some form of organization. Rules were designed to 
prevent unfair competition between the members. 
Prices were standardized. The facilities obtained by 
the companies were to be used freely by all members 
who obeyed the rules and contributed to the expense 
of operation. This latter consideration of expense 
was important. The medieval dukes and barons and 
kings who granted privileges to the merchant com- 
panies seldom did so merely out of a wish to foster 
industry and commerce. They desired some cash 
payment, and the cash had to be forthcoming from 
the companies themselves. And having obtained their 
concessions, the companies were at pains to keep out- 
siders from profiting. 

Monopolies and Regulated Companies — They at- 
tempted to secure monopolies of the trade from their 
own governments, and thus arose the system of regu- 
lated companies. In return for a consideration the 
ruler of a country granted a monopoly of a certain 
trade to a company whose rules were more or less sub- 
ject to the approval of the government. All other 
merchants of the country were forbidden to take part 
in the trade. As an illustration of these companies, 
there may be cited the Levant Company, which re- 
ceived a charter from the English king to trade in the 
spices and silks of Palestine and the East ; the Mus- 
covite Company, which had a monopoly of the trade 



THE ORGANIZATION OF PRODUCTION 81 

to Russia; the Merchant Adventurers, who traded 
with the European countries bounding the North Sea, 
and so forth. 

In none of these did the company as a whole do any 
trading. The merchants who were members of the 
company traded individually and were only associated 
together in order to secure the advantages of the 
monopolies granted to the company and of the treaty 
arrangements which it secured. 

The Chartered Companies — Perhaps the whole 
system may be better explained by taking an example 
of later date than those companies mentioned. The 
East India Company obtained a " charter " from 
James the First to trade with the peoples of the east 
coast of India. The company established " factories " 
at Madras and later on at Calcutta and Bombay. It 
arranged for protection and freedom to trade with the 
Indian princes and rulers, and bought sufficient land 
on which to erect its warehouses. The merchants who 
composed the company did an independent trade. 
Partnerships were common, but temporary. That is 
to say, each^ ship was an individual venture. Partner- 
ships would be formed between a small group of mer- 
chants to fit out a ship to sail to the Indies. When 
the voyage was over the profits were divided and the 
partnership ceased. Naturally there was a tendency 
for successful partnerships to be renewed and from this 
tendency arose the joint stock company. Before this 
can be discussed, however, it will be well to consider 
the advantages and defects of the simple partnership. 

Advantages and Defects of Partnerships — Partner- 
ships are by no means extinct. They exist in great 



82 AN INTRODUCTION TO ECONOMICS 

numbers to-day. But they only exist, with perhaps 
a few exceptions, in connection with small businesses. 
Most of modern business is done by large concerns 
whose capital is too great for the simple partnership 
to command. The partnership arises, however, from 
the fact that the average individual possesses insuf- 
ficient capital to carry on a business successfully him- 
self. He combines his capital with that of his partner 
and so is able to undertake enterprises which each 
separately could not finance. 

Obviously there is a distinct advantage, not only to 
the partnership, but to the community, in this arrange- 
ment. It means better and more economical use of 
capital. New industries become possible and old ones 
are improved. We shall notice some of the reasons 
for such improvement in the next chapter. At present 
it is sufficient to realize that the principal advantage 
resultant from the combination of two or more mer- 
chants is the possibility of widening the scope of opera- 
tions and increasing their efficiency. 

Partnerships, however, have distinct disadvantages. 
In the first place, they are naturally temporary. They 
may be dissolved at will or at the death of one of the 
partners. It has frequently happened that a good 
business has been ruined through the death of one of 
the partners and the withdrawal of his capital by the 
heirs of the dead man. Again, as far as the partners 
are concerned all is well, perhaps, as long as the business 
is successful. But in times of failure it may mean a 
great deal to one or both. For example, under the 
laws which control simple partnerships, the partners 
are each responsible for the debts of the company to 



I 



THE ORGANIZATION OF PRODUCTION 83 

the full extent of their individual resources. If one 
of the partners is a wealthy man with but a small por- 
tion of his wealth in the partnership capital, while the 
other has all his capital invested in the one business, 
on the failure of the business the rich partner may find 
that the whole of the rest of his wealth is drawn upon 
to pay for the debts of the company which has only 
been using a small portion of his capital. To put the 
matter in concrete figures, let us suppose that two part- 
ners engage in a business. One of them supplies $5000, 
which is all the funds he possesses. The other also 
supplies $5000, but has additional property worth 
$50,000. If the company fails and the debts amount 
to $20,000, then the richer of the two partners must 
pay out of his own funds the $10,000 necessary to ful- 
fill the obligations. 

Now this will prevent and has prevented the forma- 
tion of many partnerships of people with small capital. 
A man will not invest his savings in a business when he 
knows that he may be called upon to sell his home to 
pay the debts of the company, in case of failure. Hence 
partnerships are usually confined to those who are able 
to take an active share in the operations of the business 
and whose capitals are more or less equal. 

Early Joint-stock Companies — The joint-stock com- 
pany, as it used to be, was simply an extended partner- 
ship. Many men combined portions of their individual 
capital to form a company. The company was directed 
by certain of the subscribers, the total number being 
too great to take a direct share. Hence the whole of 
the fortunes of the individual investors were dependent 
upon the business ability and success of those who 



84 AN INTRODUCTION TO ECONOMICS 

directed the work. If this was sufficient, then all was 
quite satisfactory. But if the directors were not 
skillful, then it might easily happen that the sub- 
scribers had to pay for that lack of skill. 

Limited Liability — ■ The remedy for this grave de- 
fect has been found in the principle of limited liability. 
Under modern corporation laws in all countries the 
subscriber of capital toward the formation and opera- 
tion of a company is limited in his liability to the 
amount of capital which he has subscribed. If a man 
buys a share valued at a hundred dollars, it is possible 
that he will lose all that he has paid for it. But he 
need not lose any more. Should the company which 
has received his hundred dollars fail, the hundred dollars 
will probably be lost either entirely or in part, but there 
is nothing to require the subscriber to sell any other 
property to make good the debts of the company. In 
banks the law insists upon the principle of double 
liability. That is, the subscriber to the capital of 
the bank may be called upon, in case of the bank's 
failure, to pay an additional amount equal to his 
original subscription. This does not affect the princi- 
ple of the system, however. 

The value of the idea of limited liability rests upon 
the fact that a man with a small capital may use that 
capital by lending it to a company, knowing that his 
possible loss is restricted to the amount he invested. 

As a natural result from the development of the use 
of this principle, the joint-stock companies have grown 
to such an extent that they are now the commonest 
form of commercial and industrial organization. They 
have very distinct advantages over the system of 



THE ORGANIZATION OF PRODUCTION 85 

private partnership. Apart altogether from the ad- 
vantage in the matter of habihty which has already 
been mentioned, there is the great improvement in the 
life of the institution. The corporation cannot suffer 
from the withdrawal of a partner. A partner, i.e., a 
shareholder, cannot withdraw from the business un- 
less he provides some one to take his place. The per- 
sonality of the new partner, moreover, is immaterial. 
The stockholder who wishes to leave a company must 
sell his stock. The purchaser becomes the new partner 
in the business, but the policy and directorate of the 
corporation remain unchanged. Only in the case of 
the purchase of such a large block of stock as to give 
the new shareholder a decisive voice in the manage- 
ment of the company may the policy and directorate 
be changed. It is assumed, however, that the greater 
the amount of capital subscribed by a shareholder, the 
greater will be his interest in the success of the company. 
And so, if the shareholder acquires what is called a 
controlling interest, the probability is that he will 
manage the business, to the best of his ability, in the 
way which will bring the largest returns to himself and, 
presumably also, to the other stockholders. 

Theoretically, a corporation never dies. The in- 
dividual shareholders do, of course, die, but their place 
is taken by others to whom their stock is left or sold, 
and so the company goes on doing business. Again, 
the laws require always a certain minimum number 
of directors who are technically responsible to the 
stockholders for the conduct of the business. In the 
multitude of counsel there is wisdom. It is assumed 
that the inexperience of one director will be nullified 



86 AN INTRODUCTION TO ECONOMICS 

by the experience or skill of the others. On the whole 
it may be safely assumed that the corporation is usually 
more efficiently managed than the private partnership. 

Government of the Modern Corporation — The 
development of the corporation form of business is in 
line with the general development of democratic in- 
stitutions. There is a distinct analogy between the 
government of a corporation and the government of a 
democratic country. The individual stockholders cor- 
respond to the individual voters. The Board of Di- 
rectors is similar to Congress, and the Chairman, to the 
President. The Manager, Secretary, and Treasurer 
correspond to the Cabinet officers. Just as the voters 
elect Congress and the President, so do the stockholders 
elect the Board of Directors. 

Bond Issues and Bondholders — In modern times, 
however, there are other ways in which a corporation 
can obtain capital than by securing stockholders. They 
may borrow directly from the public. Of course, it is 
true that the corporation borrows money from the public 
when it issues a prospectus and obtains subscriptions 
to its capital. But the subscribers become direct 
partners in the institution, sharing its losses as well 
as its profits. If the corporation issues bonds, how- 
ever, the bondholders assume no responsibility for 
the losses of the corporation. They simply lend their [ 
capital for a definite rate of interest for a given length 
of time. As they do not share in the losses of the 
business, they do not share in its management. The 
management lies with the partners, that is, with the 
stockholders. As long as the bondliolders receive 
their interest and the principal of their loan is not 



I 



THE ORGANIZATION OF PRODUCTION 87 

endangered, they have absolutely no say in the working 
of the corporation. They are exactly in the position of 
mortgagees who have lent money on the security of real 
estate. The mortgagee is not concerned with the way in 
which his money is used. He is satisfied so long as the in- 
terest on his money is paid regularly and the property 
upon which the money is lent is efficiently safeguarded. 

Of course if the interest is defaulted, or if the prop- 
erty is obviously being depreciated so that the ultimate 
security of the money lent on the bonds is endangered, 
the bondholders may step in and, upon due legal 
process, assume control of the business. It has some- 
times happened, indeed, that bondholders have, by 
various methods, secured a great apparent depreciation 
of the assets of a corporation, and assumed control of 
a corporation, ultimately buying the assets of the 
company at public sale for a very small sum. No 
system has been invented so far, however, which is 
proof against unethical forms of manipulation in the 
interests of individuals. 

Profits of Bond- and Stockholders — It would appear 
from the above account, that the bondholders are in 
a much better position than the stockholders. Their 
principal is secured as well as their interest. Their 
interest, however, is limited to the stipulated rate, 
while the profits of the stockholders are limited only 
by the earnings of the corporation. In return for the. 
risk of loss, the stockholder gains the possibility of 
higher returns upon his investment. 

Improvements in Production Due to Corporation 
Form of Organization — The great advantage which 
results from the growth of the corporation form of 



88 AN INTRODUCTION TO ECONOMICS 

organization is the possibility of working in large units. 
It is not unvaryingly true that the larger the unit the 
better the organization. It will be noted in the next 
chapter that the law of diminishing returns operates 
in the organization of corporations as well as anywhere 
else. Nevertheless, the older organization was so un- 
economical that there has been great scope for the 
working of the reverse law of increasing returns. The 
older system meant the existence of innumerable small 
organizations with the attendant waste and duplica- 
tion of effort which characterized them. To a very 
large extent this waste can be eliminated. It has not 
been entirely removed as yet. No one with any real 
knowledge of the working of our modern organization 
will refuse to acknowledge the enormous amount of 
waste of effort and of material which goes on. There 
is more talk than actual realization of efficiency. Still, 
there is undoubtedly an improvement. The larger 
units have eliminated a great deal of the waste. To 
take one instance alone, it may be shown that our 
modern banking system, working in large units, closely 
interrelated with one another, is infinitely more ef- 
ficient than the older system of a vast number of private 
banks. 

Illustration from Banking Business — The early 
history of banking in the United States shows the 
existence of a great number of small banking houses 
frequently working with an unduly small capital. In 
fact there are instances of men starting banks without 
capital at all other than the amount necessary to rent 
a room. In order to make profits, risks which were 
far from good had to be taken. Rates of interest too 



THE ORGANIZATION OF PRODUCTION 89 

high to allow conservative business men to avail them- 
selves of loans had to be charged. The natural re- 
sults were comparative lack of assistance to good 
businesses, and overconfident financing of speculative 
enterprises. Failures were common. The credit of 
the country rested upon a wrong basis. Under the 
modern system a much more satisfactory state of 
affairs is apparent. The speculative side of industry 
is not supported by the banks to the same extent, but 
larger banking resources are open for the prosecution 
of legitimate commercial enterprises. 

The detail of these banking systems will come up 
for discussion later. At present, the system is used 
merely as an illustration of the improvement due to 
the corporation system. 

Department and Chain Stores — The development 
of the great department stores and the " chains " of 
stores is another illustration of the elimination of waste 
and the securing of economies through the corpora- 
tion system. Large capitals are necessary to these 
organizations. And large capitals cannot be obtained, 
except under very exceptional conditions, from a few 
individuals. Hence they must be the result of the 
accumulation of small investments which is the es- 
sential character of the corporation capital. Even 
in the great department stores there is waste, only too 
evident to those who manage them. But the waste 
there is infinitesimal when compared with what pre- 
vails in the small stores. Small stores buy their goods 
at a disadvantage. They must take small quantities 
at a time, and must consequently pay the high prices 
inevitably charged for small amounts. They are not 



90 AN INTRODUCTION TO ECONOMICS 

in a good position to judge of markets. Their own 
market is confined to a small radius and there is con- 
sequently little possibility of goods not wanted in one 
locality being disposed of by selling them in another. 
The department store reaches a much wider market 
and can afford to buy in much greater quantities with 
the certainty of being able to dispose of a much greater 
variety of goods than can the small dealer. The vary- 
ing wants of wider markets can be satisfied with less 
waste. 

The village tailor can only have a small range of 
material for his customers to choose from. If he has 
a wide range, he will probably find that much of his 
stock remains on his shelves. Hence his customers 
cannot satisfy themselves readily. They will prefer 
to deal with the city store which has variety to satisfy 
all tastes and which can nevertheless turn over its 
stock much faster than the village tailor can hope to 
do. No further illustrations are necessary. Common 
observation will furnish infinite numbers to prove the 
truth of the contention that the large capital usually 
means greater efficiency. 



CHAPTER VIII 

THE ORGANIZATION OF PRODUCTION (continued) 

It is not only in business that great strides have been 
made during the past century. The industrial world 
has moved too, and, indeed, shows even more differ- 
ence from the crude methods of the past than does the 
business world. Space does not permit of an exhaus- 
tive account of the new developments, but the principles 
upon which the present organization is based can be 
indicated without occupying too much of our attention. 

Agriculture as Industry — As was suggested in the 
last chapter, it is advisable to consider agriculture as a 
branch of industry. There is really no essential dif- 
ference between agriculture and manufacture. The 
agriculturist merely applies his skill and knowledge 
to the changing of the chemical constituents of the 
soil into food and the raw material of fabrics. The 
farmer's aim as an agriculturist, apart from the pri- 
mary necessity to obtain profits, is to produce from the 
soil the greatest quantity and best quality of crop that 
can be obtained. He should always strive to improve 
his production in both directions, and his success may 
be illustrated by reference to the methods and results 
of past systems. 

Primitive Agriculture — Primitive agriculture con- 
sisted of a simple scratching of the almost virgin soil 

91 



92 AN INTRODUCTION TO ECONOMICS 

and allowing the processes of nature to work with 
little assistance from the farmer. Even as late as 
the seventeenth century, the highlander plowed the 
mountain sides in Scotland by means of a primitive 
implement tied to the end of the ox's tail. The actual 
origins of agriculture are doubtful. Probably man 
learned very gradually that the growth of the wild 
crops could be stimulated by simple tilling of the soil, 
exposing to the sun fresh earth. With this as a basis, 
and with very little knowledge of the effects of cropping 
upon the constituents of the soil, his knowledge was 
increased by experience when he found that continual 
cropping with the same cereal impoverished the soil. 
Various methods were adopted to prevent this im- 
poverishment. Possibly, as the farmer wandered from 
exhausted fields to virgin soil he arrived in his wander- 
ings at last at a field which had already been tilled and 
left upon its exhaustion. He discovered that in the 
interval during which the land had lain idle it had 
regained its fertility, and thus arose the knowledge of 
the value of letting land lie fallow. Every one is famil- 
iar with the biblical method of allowing one year in 
seven to the soil in which to recover its resources. The 
method adopted in the northern parts of Europe from 
which our ancestors came was somewhat different. 
There the cultivated lands were divided into three 
parts, two of which were tilled each year while one 
remained fallow. Each of the " fields " had its turn 
of fallow once every three years. ■' ' 

Communal Tillage — The lands were tilled in com- 
mon, although not necessarily communally owned. 
Each of the cultivated fields was divided into strips. 



THE ORGANIZATION OF PRODUCTION 93 

separated from one another by " balks " of grass — 
strips of grass from four to six feet wide. Each of the 
cultivators possessed the produce recovered from one 
or more of the strips. When the crops had been reaped 
and the cattle fed upon the stubble, the time came for 
the re-cultivation of the field. The strips were divided 
among the cultivators again, although it did not follow 
that each would receive the same strips whose produce 
was his property in the previous year. 

This three-field system was a distinct improvement 
over the old system of continuous cropping to the 
point of exhaustion, but it was nevertheless wasteful. 
Moreover, the communal method of operating the 
land made it almost impossible to conduct experiments 
for improving the crops. 

Difficulties in the Way of Progress — There is a 
general feeling that farmers are a conservative class, 
hating innovations. That may not be true at present, 
particularly in America, but it undoubtedly was so in 
the past. And when there came a farmer sufficiently 
radical to suggest a new method, he found it almost 
impossible to persuade his fellow cultivators to agree 
to the " new-fangled " idea. Progress was only possible 
when experiments were made upon land which was not 
included in the three-field system. In England the 
system broke down during the eighteenth century. 
The individual farms were " inclosed." That is, each 
of the cultivators became the possessor of an amount 
of land roughly equivalent to the area whose produce 
he had formerly received. Then the individual could 
experiment for himself, if he so wished, without con- 
sulting the opinions of other farmers. It was during 



94 AN INTRODUCTION TO ECONOMICS 

this period that what was known as Dutch culture was 
inaugurated. In other words, continuous cropping 
with one crop gave place to a rotation of crops, it hav- 
ing been found that what one crop took from the soil 
was replaced by another. 

The experiments of some cattle breeders at the same 
time improved the breed of cattle to an extent which 
seemed almost miraculous. This was made possible 
by the utilization of root crops for winter feed. 

Extensive Culture in America — The greatest strides 
in farming methods, however, occurred in the American 
continent. Here was a land in which virgin soil seemed 
almost inexhaustible. Careful tilling was not, at first, 
necessary. The size of the farms was infinitely greater 
than in Europe, where for centuries almost every avail- 
able acre had been tilled. When a larger crop was re- 
quired, instead of manuring the existing farm land, 
fresh virgin soil was plowed and sown. The wide area 
of land under tillage and the comparative scarcity 
of labor tended to encourage the use of labor-saving 
machinery, and to-day America is preeminently the 
land of machine farming. Virgin soil no longer exists 
in unlimited acres. Careful cropping is necessary, and 
the wide areas cultivated must employ the best of the 
machines in order to provide food not only for the culti- 
vators themselves, but also for the peoples of the old 
world, who have come to depend very largely upon the 
produce of America for their daily food. 

For a comparatively long period, American farms 
worked under the law of increasing returns. Intensive 
culture in Europe had shown that land could be im- 
proved in quality and greater crops secured by the 



THE ORGANIZATION OF PRODUCTION 95 

artificial supply of chemicals which were lacking in 
the soil. But Europe had reached the stage where 
the law of diminishing returns was in operation, and 
although the powers of the soil were improved each 
addition to the crops cost a proportionately greater 
expenditure of labor and capital. America learned 
from the experience of Europe, and vast changes have 
been made in the methods of agriculture. Farmers 
have at their service the best knowledge of the govern- 
ment experts, and the universities have devoted much 
attention to improving methods and to ehminating 
the drawbacks to successful cultivation. 

Increased Use of Fixed Capital — The essential 
change in our methods of agriculture, however, is due 
ultimately to the increased amount of fixed capital. 
The simple plow drawn by horse or ox has given 
place to the steam or gasoline tractor drawing many 
plows. Seeding, harrowing, reaping, binding, and 
threshing are all done by machinery, and done more 
economically and with better results than formerly. 

The use of machinery, while it has proved infinitely 
more satisfactoj^y than hand labor, has not diminished 
the number of people engaged in farming. On the 
contrary it has increased the number dependent upon 
agriculture for their living to an enormous extent. It 
is true, however, that this increase, big as it is in actual 
numbers, is not proportionate to the increase in popu- 
lation. Irrigation, involving an immense expenditure 
of capital and labor, has brought into cultivation areas 
which used to be deserts. The needs of a growing 
manufacturing community have demanded an increase 
in production which has made it profitable to apply a 



96 AN INTRODUCTION TO ECONOMICS 

new army of agriculturists, armed with the best weapons 
of the modern scientific farmer, to the cultivation of 
all available soil. The new methods have lightened 
the lot of the farmer, and the increased means of com- 
munication, necessary for the removal of his produce, 
have brought him into closer touch with his neighbors, 
and stimulated him mentally. 

Manufactures. Subordinate Nature of Early Manu- 
facture — Although agriculture has made great strides it 
is in the manufacturing side of industry that the great- 
est changes are to be seen. Formerly all manufacture 
was carried on merely as an adjunct to agriculture. 
Agriculture was the mainstay, and a limited amount of 
specialization allowed of the existence of trades un- 
connected with farming. The smith and the carpenter 
did not devote any of their time to farming, or, at least, 
devoted very little; but the spinning and weaving of 
cloth were carried on by the farmers themselves. 
Manufacture then meant what the word really signifies, 
the making of things by hand. The spinning wheels 
and the hand looms were hand made. They were 
operated by hand in the houses of the working people. 
Industry was domestic, but it was not without its 
organization. 

The Gild System — When specialization of occu- 
pation grew to such an extent that trades developed 
beyond the simple blacksmithing and carpentering; 
when the butcher and the baker developed their crafts 
and the gold- and silversmiths arose, each craft at- 
tempted to secure the welfare of those who carried on 
those industries. They united in organizations which 
were termed gilds. The gilds were bodies which 



THE ORGANIZATION OF PRODUCTION 97 

comprised all who were engaged in a particular craft, 
or trade. They were organized under definite rules 
which provided for all the necessities of the trade. 
Before a workman could be admitted, he had to pass 
through a period of apprenticeship, during which he 
lived with his employer. The employer undertook to 
teach him the craft and to clothe and feed him while 
he learned. At the end of his apprenticeship he be- 
came a journeyman and looked forward to the time 
when he could begin business himself as a master. The 
gild included those in all three stages — apprentices, 
journeymen, and masters. Rules prevented one master 
from obtaining more than his share of the amount of 
work to be done; the manner of the work done was 
criticized by the officers of the gild in orderl to main- 
tain good standards of workmanship. Competition 
was not allowed. 

The sick and infirm among its members were cared 
for by the gild funds, from which also the orphans 
and widows of deceased members were aided. 

The gilds broke down very largely because of an 
ever growing strictness in the rules for admittance. No 
one was allowed to practice a craft who did not belong 
to the gild in his district. He could only be admitted 
to the gild as an apprentice, or upon payment of a 
heavy entrance fee. Then the apprentices were charged 
fees which grew to such an extent that they became 
almost prohibitive. The gilds became close corporations 
instead of free associations, and the resultant outside 
competition gradually broke down their organization. 

Manufacture on a Small Scale — Whether organized 
in gilds, however, or working as free individuals, the 



98 AN INTRODUCTION TO ECONOMICS 

workmen carried on their occupations on a small scale. 
Factories did not exist, although as early as the fifteenth 
century there were evidences of the possibilities of 
factory organization. 

The Factory System — It was not until the advent 
of the age of the great inventions that factory organiza- 
tion came into being to any great extent. The latter 
part of the eighteenth century saw the invention of 
many new machines, particularly applied to the textile 
trades, which rendered necessary the grouping of work- 
men in buildings. The change from the older system 
was at first gradual, but toward the end it came with 
increased speed. Under the older method, at first, the 
workman owned the building in which he worked, the 
tools of his trade, the materials from which the product 
was made, and he supplied the power from his own 
physical energy. He gradually came to work upon 
materials supplied him by others. Later he worked 
with tools lent to him by the owners of the materials. 
Still later those same owners supplied the buildings 
in which he worked and at last the power which drove 
the tools, or machines, ceased to be his own physical 
force, and was derived from steam. 

Increased Use of Fixed Capital in Manufacture — 
With each stage of development there is seen an in- 
crease in the amount of fixed capital necessary to carry 
on an industry. When spinning and weaving were done 
by hand, the tools were simple and every peasant had 
his spinning wheel and hand loom. When the spinning 
jenny and the power loom were to be used, the cost 
was too great for the individual, unless he possessed a 
large amount of capital. The workman lost more and 



THE ORGANIZATION OF PRODUCTION 99 

more the possibility of becoming a master and tended 
to become a mere wage earner, supplying nothing but 
his physical powers and his skill toward the manu- 
facture of the completed product. 

With each stage of growth there is seen an increase 
in the amount of production from the individual. 
Each stage means an increased use of the principle of 
division of labor. With every additional machine 
the necessity for the use of highly skilled labor is 
lessened, and, as a consequence, the average produc- 
tivity of the workman is increased. Factory organiza- 
tion is not profitable unless there exists a market for a 
large production. Those industries which command 
only a very small market still depend upon the skill 
of the individual workman. 

It is in the organization of industry on the factory 
basis that the best examples of the law of increasing 
returns can be seen. When the industry is on a small 
scale, each of the workmen must perform the greater 
number of the operations necessary to turn out the 
finished product. In the manufacture of furniture, for 
instance, if the work is done in a small workshop, em- 
ploying perhaps two or three workmen, the amount 
produced does not warrant much machine work. 
Hence there is a great deal of handwork in the neces- 
sary planing, sawing, fitting, etc. Each of the work- 
men divides his time among the various occupations. 
At one time he is drawing the design of the cabinet 
or whatever is to be made. Then he is cutting out 
the different shapes which he must proceed to plane 
and fit up. Finally he smooths the whole and turns 
it out ready for polishing. He cannot be expert at all 



100 AN INTRODUCTION TO ECONOMICS 

the operations. Or, at least, he cannot be as expert 
as one who spends his whole time in one operation. 

Under the factory organization the shapes can be 
cut by machinery in large numbers. The workmen! 
necessary to operate the machines are few in com- ! 
parison with the amount turned out. The planing 
and fitting are done by machinery also, and likewise 
the sanding and finishing. If the expense of pro- 
ducing each particular part of the finished piece of 
furniture be calculated under the hand- work system and 
under the factory system, it will invariably be found 
that the cost of the latter method is very much less 
than that of the former. On the whole it is safe to 
say, also, that the factory work will be better done, 
provided that the element of individual artistry does 
not enter into the product. Each of the workmen, 
aided by the machines specially designed to perform 
functions formerly carried out by hand, acquires a 
skill and speed which were impossible to the all-round 
cabinet maker. With each additional application of 
capital and. labor, then, under the factory system of or- 
ganization, it can be shown that, up to a certain point, 
there is a greater productivity both in general and 
proportionately . 

But this is only true up to a certain point. There 
comes a time when the factory has reached its limit 
for satisfactory production and the law of decreasing 
returns operates. Managerial ability, for instance, is 
only capable of handling units of organization of a 
limited size. Experience has shown that when a 
factory has reached the stage when further expansion 
of the individual unit does not produce a 'proportion 



I 



THE ORGANIZATION OF PRODUCTION 101 

ately greater return, a more satisfactory method of 
production is to organize another unit. 

Complexity of Modern Trade Forms — The first 
of the economies resultant from factory organization, 
then, is the increased use of the principle of specializa- 
tion or division of labor. The Thirteenth Census of 
the United States gives a list of over one hundred 
forty different forms of industry, many of which have 
within their own limits over a hundred different trades. 
The cotton industry and the boot and shoe industry, 
for instance, have upwards of one hundred fifty differ- 
ent trades. 

Elimination of Waste — The second economy which 
is a direct result of the factory system is the elimina- 
tion of a large amount of waste. Goods can be bought 
in larger quantities and can be more skillfully selected. 
The better parts of the product can be used for the 
more important portions of the finished articles. 
Waste cut from the better goods can be used in the 
construction of less important parts. 

Transport is economized through the use of car- 
loads of goods instead of small individual orders. Over- 
head expense — rent, lighting, heat, office service, 
and so on — is much less per unit of 'production. By- 
products can be much better dealt with when the in- 
dustry is on a large scale than under the older small- 
scale organization. 

Problems of Production — The problems of produc- 
tion have not been decreased, however. They are 
still as numerous and as important as formerly. But 
the large-scale production has made possible the 
scientific attempts at solution of the problems. With- 



102 AN INTRODUCTION TO ECONOMICS 

out attempting to make an exhaustive list of these 
problems, the main elements may be indicated. 

I . Location of Industry — First there is the prob- 
lem of the location of the industry. Under small-scale ' 
production industries were scattered far and wide and 
little attempt was made to locate the industry in the 
most suitable position. Transport being badly organ- 
ized, the market for the sale of goods of any kind was 
necessarily small and hence production was scattered 
over a large number of small units. With transporta- 
tion improved (and this is only possible where there is 
large production to keep the systems of railroads, 
canals, and ocean carriers busy) , industries could select 
the best situation. 

In deciding the location of an industry some of the 
points to be considered are as follows : 

First, labor must be available, and labor of the right 
class. It would be folly to set up, say, a watch-making 
plant, where the only labor available was that of, let us say, 
Indians. 

Second, the raw product must be easily obtained. Raw 
material should not be drawn from a distance unless trans- 
portation is cheap or unless it is drawn from a spot where the 
actual manufacture is impossible for other reasons, as in the 
case of the rubber industry, for example. 

Third, power for the machinery must be easily obtained. 
This means proximity to coal supplies or electric power. 
Finally the markets for the sale of the goods must be con- 
venient. This does not necessarily mean that the markets 
should be near. But they must be reached without undue 
expense for transportation. In the early years of the eco- 
nomic history of the United States human food products 
were often used for feeding pigs, as the cost of transporting 



THE ORGANIZATION OF PRODUCTION 103 

them for a greater distance than twenty or thirty miles was 
so great as to make the'price to the consumer prohibitive. 

2. Capitalization — The second problem is that of 
capitalization. The funds for the initial expense of 
commencing the industry must be procured. A de- 
cision must be made as to the methods of financing the 
new industry. This is a matter which will be con- 
sidered in greater detail in the next chapter. In all 
probability the industry must be run with borrowed 
capital. That is, it must avail itself of the funds of 
investors who look to a return on their investment 
without themselves contributing much time to the 
management. 

3. Factory Organization — Having selected the site 
and obtained the funds, the next step is to organize 
the factory. The directors of the corporation will be 
elected by the stockholders. They in turn will ap- 
point their president and officers. Of these latter 
there are three of great importance, the production 
manager, the office manager, and the sales manager. 
The production manager will plan very carefully the 
arrangement of all the machinery so that there will 
be no waste motions in sending the partly finished 
product from one machine to the next. He will decide 
the number and grouping, the training and payment 
of the workers ; the purchase and storing of the raw 
materials and partly finished goods. 

The office manager will attend to the accounting 
processes. He must keep track of all disbursements and 
receipts, calculate the profits and losses, so that a clear 
presentation of the state of the business can be made 
at any time. 



104 AN INTRODUCTION TO ECONOMICS 

The sales manager must take care of the processes 
necessary to distributing the goods to the consumers. 
He will control and train the sales force, arrange for 
advertising, and so forth. Each of these managers is 
essential. In small businesses, of course, the three 
may be included in one individual, but the larger the 
business the more necessary is it to specialize. It is 
seldom true that the most efl&cient production engineer 
is also an efficient salesman or accountant. And the 
good accountant cannot be expected to have an expert 
technical knowledge of the manufacture of the product 
of the business. 

4. Scientific Management — In the actual methods 
of production there is room for improvement in a great 
many ways. The most carefully thought-out method 
of production is, perhaps, that of those who have de- 
veloped what is known as Scientific Management. 
Under scientific management the production is first 
analyzed into its main parts. Then a further analysis 
is made of each part until finally the individual motions 
of the workman are considered. 

An expert workman is set to perform his usual task. 
While he is at work every action is noted, sometimes 
moving-picture records being taken. Wherever waste 
effort, useless motions, or strain of any kind can be 
seen, attempts are made to alter the motions so as to 
eliminate the waste. These attempts sometimes mean 
changes in the handling of tools by the workman, some- 
times changes in the design of the machine. Occasion- 
ally additional new machinery is suggested. 

When the final motions are arrived at, perfected 
after many discussions, each of the workmen is trained 



THE ORGANIZATION OF PRODUCTION 105 

in the perfected methods. The materials are routed 
in the best possible manner, and the workmen are 
stimulated by the offer of higher rates of pay. 

There can be no doubt whatever that scientific 
management, properly carried out, results in a very 
great improvement in efficiency. In actual experience 
it has been shown that efficiency of average workmen 
can be increased as much as three or four hundred per 
cent. It must be admitted, however, that there is a 
tendency occasionally to consider the workman too 
much in the light of a machine. This is due rather to 
a wrong interpretation of the system than to the idea 
of scientific management itself. 

A careful use of the knowledge of the dangers of 
fatigue and of the importance of rest and change, 
gained from the experiments of the psychologists, re- 
moves much of these dangers. The danger of under- 
payment, one of the commonest causes of inefficient 
work, can also be removed by a sound application of 
the principles of scientific management. The key to 
the system is to be found in the scientific observation 
of method with a view to eliminating all waste effort 
and the scientific application of psychological knowl- 
edge to the conditions necessary for the best production. 
This latter point includes the consideration of the 
stimulus to efl'ort due to good working conditions and 
the contentment resulting from just compensation for 
work done. 



CHAPTER IX 
THE ORGANIZATION OF CAPITAL 

In an earlier chapter it was stated that the present 
system of economic organization was one of modified 
competition. The question now to be considered is 
the means whereby competition between the owners 
of capital has been eliminated. The whole basis of 
the organization of capital consists in the attempt on 
the one hand to eliminate competition and on the other 
to make that competition which remains as efficient 
as possible. 

Failure of Competition — It is now generally ad- 
mitted that, as a method of production, competition 
is wasteful. When each owner of a small amount of 
capital puts that capital to work in an industry con- 
trolled by himself, the industrial units are necessa- 
rily small. Hence all the disadvantages of small-scale 
production are present. In distributing the product, 
too, there are grave disadvantages. When too many 
are competing, the tendency is to cut prices to so low 
a level that none gets a reasonable return on his ex- 
penditure of capital and labor. 

Limitation of Competition, i. The Corporation — 
The competitive system had not been developed to a 
great extent before it was realized that unlimited com- 
petition meant small profits. The establishment of 
the corporation form of business, under the principle 

106 



THE ORGANIZATION OF CAPITAL 107 

of limited liability, was in itself a curtailment of com- 
petition. It meant the combination of a great number 
of comparatively small capital sums which, working 
independently, would otherwise have produced a great 
number of small competing businesses. The unit of 
production was greatly increased. But even with this 
increase in the size of the unit, competition was still 
so keen that some form of cooperation was bound in 
time to supersede it. 

2. Price Agreements — The great difficulty that 
was felt was the lack of control over prices. When 
prices were fixed entirely by competition, the tendency 
was to reduce them to the lowest level. This was un- 
satisfactory from the point of view of the manufacturer, 
although it had an undoubted advantage, at least ap- 
parently, from that of the consumer of the manufactured 
goods. Realizing that indiscriminate and undue com- 
petition meant small profits, manufacturers first agreed 
to fix prices by mutual consent. Such price agree- 
ments have been very common during the past hundred 
years. They exist to-day in many industries, and they 
have undoubtedly caused a rise in prices with conse- 
quent satisfaction to the manufacturers. 

But an agreement to maintain prices represented 
also an agreement to control production. In gerueral 
it may be said that the higher the price of an article, 
the smaller will be the quantity sold. If then, an agree- 
ment is reached whereby prices throughout a par- 
ticular industry are maintained at a fairly high rate, 
following on a period of competitively fixed low prices, 
there will obviously occur a reduction in the amount 
of the goods actually sold. That means a curtail- 



108 AN INTRODUCTION TO ECONOMICS 

ment of production/ Now each of the manufacturers 
who has signed the agreement to maintain prices is 
anxious to maintain as high a production as possible 
so as to reap the full benefit of the more profitable 
scale of prices. If there is no other method of curtail- 
ing competition than a mere agreement as to selling 
prices, there will inevitably be a tendency for some 
member of the associated group to try a slight secret 
cut in prices in order to get a larger share of the sales. 
Hence there arises at the very outset a tendency for 
the agreement to break down. For a cut in prices 
cannot long remain secret, and an agreement which is 
not carried out is worthless. 

Such an agreement has as much actual value as 
would a law for the breach of which no penalties were 
provided. If there were no punishment for theft, for 
instance, there cannot be any doubt that the crime of 
theft would increase. This is not an argument for all 
sorts of punishments, of course, but it is obviously 
true that a law is of no value if there are no provisions 
for making it effective. In regard to these price agree- 
ments the necessity for some form of compulsion on 
the members of the associated group has been readily 
seen. In some cases fines have been instituted by the 
association for any breach of the agreement. But 
even these fines are not very satisfactory unless there 
is some means whereby the payment of the fines may 
be enforced. To enforce this payment it has some- 
times occurred that the members of the group, upon 
signing the agreement, deposited with an executive 
committee or some outside body the amount of the 
fine. Then if any breach of the agreement were proved, 



THE ORGANIZATION OF CAPITAL 109 

the fine was automatically forfeited and became the 
property of the group as a whole. 

Example of Price Agreem^ent — One of the best 
examples of a simple price agreement is that of the 
North Atlantic Passenger Conference. This shows at 
once the advantages and disadvantages of the system. 
The Conference was formed for the purpose of main- 
taining a uniform schedule of passenger rates, par- 
ticularly third-class rates, on the lines running from 
the European ports to the United States. These rates 
have been maintained on the average at something like 
thirty to thirty -five dollars. Once or twice, however, 
a member has broken away from the group, believing 
that it could obtain a greater proportion of the traffic 
by a slight reduction of prices. There immediately 
ensued a rate war. The other members of the Con- 
ference at once entered into fierce competition with 
the recalcitrant company. Rates were reduced at 
times to as low as twelve or fifteen dollars for a third- 
class passage. This was considerably less than the 
cost to the companies, and obviously, therefore, the 
war could only continue for a limited period when a 
new agreement was reached. 

3. The Kariel — In order to prevent the periodical 
recurrence of such rate wars a further agreement is 
necessary, an agreement to divide the total business 
equitably among the producers. This form is repre- 
sented in the German Kartels. The Westphalian 
Coal Syndicate is perhaps the best example of this 
sort of organization, although the former Michigan 
Salt Association provided an American illustration. 
The Coal Syndicate made a careful estimate of the 



110 AN INTRODUCTION TO ECONOMICS 

amount of coal which could be sold at a remunerative 
price and then distributed the total necessary pro- 
duction among its members in proportion to the extent 
of their productive powers. The selling of the product 
was carried out, not by the individual members of the 
syndicate, but by the syndicate as a whole through 
what were known as Selling Bureaus. 

The result of this form of organization has proved 
very satisfactory to the producers in those countries 
where it still exists. In some countries, however, as 
in the United States, these Kartels are deemed to be 
contrary to the common law, under which they are 
considered to be conspiracies in restraint of trade. 

4. The Pool — Another method which has had nu- 
merous examples is what is known as the pool. There 
are various forms of pool, however, of which we 
shall consider only the most important. The principal 
form was an agreement to pool all orders and have 
them executed proportionately to productive capacity 
of the members and to pool also the prices obtained 
by the sale of the goods. 

All such agreements, however, have the very grave 
defect that they still permit of the existence of dupli- 
cated effort. It is quite possible that two or three 
members of the group have facilities sufficient to pro- 
duce all the goods necessary to satisfy the market, or 
at least to satisfy all the demand at the price which the 
association deems remunerative. The work of all the 
other producers, therefore, is more or less wasteful. 
If there is to be real efficiency, there must be control 
of both ends of the business, the producing as well as 
the selling end. Although the price agreements elimi- 



THE ORGANIZATION OF CAPITAL 111 

nate competition from the selling department, com- 
petition among the producers is still allowed. In 
order that all competition should be removed a greater 
approximation to monopoly of both production and 
selling must be made. 

5. Monopolies — The great tendency of modern 
times is towards the development of monopolies. In 
this chapter no attempt will be made to discuss monopo- 
lies from the standpoint of the consumer. This must 
be left for future discussion. At present our concern 
is with the methods of organization and the nature of 
the economies produced. 

Monopolistic organization is only possible where 
the economies of large-scale production can be secured. 
In those industries where individual skill is necessary 
there is little if any tendency to monopoly. There is, 
for instance, no possibility of monopoly in the paint- 
ing of pictures. But there is undoubtedly much 
greater possibility in the reproduction of those pictures. 
The original paintings require a certain amount of 
individual skill and insight into the artistic values. 
The reproduction of the pictures involves the use of 
more or less mechanical processes. The reproduction 
of famous paintings on picture postal cards which are 
sold by the million is a large-scale business. The 
original paintings were the work of great artists. The 
same is true of the modern printing business as com- 
pared with the medieval form of copying manuscript. 
The monks of the middle ages made their copies of the 
writings of the fathers works of art in themselves. The 
modern printer makes thousands of duplicates, in which 
the artistic effort in producing one is reproduced exactly 



112 AN INTRODUCTION TO ECONOMICS 

in all of the others. Hence large-scale production is 
necessary, where formerly it was impossible. 

There are very many forms of monopolies successful 
in a greater or less degree, and known by names which 
are commonly used in ordinary speech. So common 
are these terms, however, that they are frequently 
misused. The average person who speaks of trusts, 
for example, seldom does so in the accurate sense. To 
him the word trust is synonymous with monopoly. 
Now it is fairly true to say that, with the exception of 
those industries which are definitely the care of the 
governmental organization, such as the post office, 
there is no true monopoly existent. There are organi- 
zations which approach monopolies, however, and it is 
with these that we must deal. 

6. The Trust — The most familiar term is the Trust. 
The word was first used in connection with a particular 
form of organization arising out of the growth of the 
Standard Oil Company. In this case a number of 
competing corporations were grouped together, and 
the stock of the individual corporations was assigned 
to a group of Trustees in return for Trust Certificates. 
The whole of the organization of the united corporations 
was left in the hands of the Board of Trustees and 
dividends were paid on the trust certificates and not 
on the original stock. This form of organization was 
not objected to merely on account of the form, but 
rather on account of the monopoly which was thereby 
attempted. The form was attacked under common 
law on the ground that it was a conspiracy in restraint 
of trade, and so was no longer permissible. But al- 
though the trust form has disappeared, the institu- 



THE ORGANIZATION OF CAPITAL 113 

tions which were combined under that form still re- 
main. The form is changed, but the fact remains the 
same. The principal form under which what were 
formerly trusts and what are now often called trusts 
are organized, is more accurately known as the holding 
corporation. 

7. The. Holding Company — It will readily be under- 
stood that the control of a corporation rests in the 
hands of the stockliolder or group of stocldiolders who 
control a majority of the stock. As a rule each share 
of stock carries one vote. If five men club together 
to buy a share of stock for a thousand dollars, they 
have between them the right to one vote at the stock- 
holders' meetings. If one man owns a hundred of 
such shares, he has one hundred votes. In any case, 
then, the man or group who owns fifty-one per cent of 
the stock is able to outvote all the other stockholders. 
They have no more say in the management of the 
business than if they had no stock at all. Indeed it 
is not really necessary in most cases for the individuals 
to possess the whole of the fifty-one per cent. All they 
need to secure absolute control is to secure that amount 
of voting power. A compact group or single indi- 
vidual who owns let us say, forty per cent of the stock 
of a company, has usually the power of deciding who 
is the president of that company and the board of 
Directors, unless the remaining stock is held by an- 
other individual group. If it happens that the rest 
of the stock is held by a great number of small holders, 
then his power is practically supreme. For the great 
majority of the stockholders will not vote personally 
at the general meetings. They will send their 



114 AN INTRODUCTION TO ECONOMICS 

" proxies " as a rule to the President of the Corpo- 
ration. The group or individual who controls the 
appointment of the president, therefore, controls 
also the voting of the proxies, as well as of his own 
shares. 

It is obvious, therefore, that in order to decide the 
policies and methods of operation of a company, all 
that is necessary is to gain control of fifty-one per cent 
of the voting power in that corporation. Now sup- 
pose a group of men wish to control several corpora- 
tions. They may pool their capital and with the total 
obtain control of each of the companies. Their " pool " 
may be organized under the corporation laws as a 
" corporation formed for the purpose of holding stock 
in " such and such companies. This new corporation 
does not need to possess all the capital of the indi- 
vidual companies which it desires to control. At most 
all that is required is the fifty-one per cent of stock, 
and even this amount, if the work of the holding corpo- 
ration is skillfully carried out, need not be necessary. 
Essentially there is no difference between this form of 
monopolistic organization and the older form of the 
trust, except, possibly, that the new form gives the 
same results with a little more economy of capital. 

The holding-corporation form makes possible the 
control of a great industry by a small group who, of 
themselves, possess only a comparatively small pro- 
portion of the capital necessary to conduct the in- 
dustry. Figure 2 will help to illustrate this possi- 
bility. The four squares. A, B, C, D, represent, let 
us say, four boot-and-shoe-making corporations, each 
capitalized at one hundred thousand dollars. 



I 



THE ORGANIZATION OF CAPITAL 



115 



The Holding Corporation holds fifty-one per cent of 
the stock in each of the companies. Its total capitali- 
zation consists merely in the amount of stock of the 




'/ao,ooo 






HOLOiNG 
COM PANY. 

4>2.0^,000 




S;^ 



c 






^ 



4>fOO,OOQ 



1 

m 


b 



^/OO.OOQ 



F/G.Z. 

other companies which it holds, and this amounts to 
two hundred and four thousand dollars. With this 
sum it is able to control a capital of four hundred 
thousand dollars. But this is not all. The stock in 



116 AN INTRODUCTION TO ECONOMICS 

the holding corporation may have been put on thej 
market, with the exception of fifty-one per cent neces- ; 
sary to reserve control for the principal stockholders, j 
These latter, therefore, with a capital of a hundred and 
three thousand dollars are able to control entirely the ' 
corporation's two hundred and four thousand dollars, 
and thus in turn control the working of the four boot- 
making companies. 

This is the form in which most of the modern 
" trusts " are organized, and a recent enumeration 
gives a list of some two hundred and thirty such 
organizations. 

Another form is the merger. This is merely the 
absorption of one organization by another, or the com- 
bination of two or more corporations into one. 

Uniform Object to Eliminate Competition — What- 
ever be the form, however, the aim is the same in all 
cases. It is to eliminate competition to as great an 
extent as possible. Actual monopoly, as has already 
been said, has not been attained. But actual monopoly 
is not necessary for the purpose of controlling prices. 
If the competing companies are only able to supply a 
small portion of the total production, it is likely that 
they will, without any formal agreement, charge a 
price which is approximately equal to that charged 
by the " trust." If they make an unduly strong at- 
tempt to beat the monopoly's price, they will subject 
themselves to very severe competition, which may 
easily ruin them. 

Effects of Monopoly Organization — It is not an easy 
task to estimate the effects of such quasi-monopolistic 
organizations. As far as the securing of large-scale 



I 



THE ORGANIZATION OF CAPITAL 117 

production economies is concerned, it is probably true 
that the monopoHstic form is economical, but it is not 
necessarily so. There may still be a great deal of 
waste, and if the monopoly is very powerful, it may 
lack the stimulus necessary to force it to secure all the 
possible economies which production on a large scale 
should entail. 

Again, it is quite true that monopoly organizations 
may find it more profitable to sell a comparatively 
small amount of goods at a large unit price than to 
sell great quantities at a smaller figure. This question 
of monopoly price, however, is one which will come up 
for consideration in a future chapter. 

Improvements in production are not always in- 
troduced readily in a monopoly. This is one of the 
criticisms aimed at government operation of businesses. 
Improvements in manufacturing methods often entail 
very heavy expenditures for new machinery while the 
old may not be nearly worn out. It has been charged 
against several big combinations that they have bought 
up patent rights to new inventions with the definite 
idea of preventing the new inventions being used. 

On the reverse side, it may be said that considerable 
overlapping of production may be avoided under a 
monopoly organization. Unnecessary competitive ad- 
vertising may be saved. It is often urged, also, that 
benefits to the consumer result from lower prices 
charged by monopolies. It is true, indeed, that some 
monopoly commodities, as, for example, illuminating 
oil, have become cheaper under partial monopolies 
than they were formerly under free competition. But 
that does not mean that the prices charged are as low 



118 AN INTRODUCTION TO ECONOMICS 

as they ought to be. It may be that had free com- 
petition still obtained, together with more modern 
methods of production, the price would be still lower. 

Control of Monopolies — The question of the con- 
trol of corporations which approach the monopoly 
form is one which is exciting a great deal of public 
interest. This is naturally so, for the public is quite 
right in being anxious not to let the important serv- 
ices and commodities of life drift into the hands of a 
small group whose only interest is to make the highest 
amount of profit. The arguments usually alternate 
from the advocacy of government control to that of 
government ownership. Without at present discussing 
the arguments in detail, it may be said that there is 
considerable justification for each point of view. It 
is doubtful at present whether the governmental forces 
are sufiiciently well organized to take charge of the 
operations of great manufacturing industries. But 
these organizations must be subject to some form of 
control. They must not be allowed to levy tribute 
upon the general population. Control, however, is 
a word with only relative force. Some government 
interference is, if not exactly welcomed by the monopo- 
lies, at least easily tolerated. The tendency, however, 
is towards the increase of control to the point where 
the distinction between control and ownership almost 
ceases. 

Justification of Monopolies — Whether it be owner- 
ship or control, however, there can only be one justi- 
fication for the existence of monopolies. That is, they 
must be able to work with economies impossible under 
a system of modified or free competition. They must 



I 



THE ORGANIZATION OF CAPITAL 119 

actually eliminate waste in production. Prices must 
not be based on the idea of securing the largest profit, 
but rather with a view of securing the widest sale at 
a price which provides the normal return for capital 
and labor. 

Further the capitalistic organization must be such 
as to protect the small stockholder as well as the large. 
Under the holding-corporation system, the small stock- 
holder stands little chance of protecting his interests. 
Theoretically he has a vote, but a theoretical vote is 
of little importance when it is always overthrown in 
practice. 

A further point arises in connection with the per- 
mission of competing organizations in businesses which 
are of the nature of monopolies. Most public utili- 
ties are best operated as monopolies, whether publicly 
owned or not. Competing street car and lighting 
systems, or telephone systems are undoubtedly un- 
desirable. Past experience in many cities has proved 
this beyond a doubt. At the time of writing, the crisis 
of a world war has brought into prominence the evil 
effects of competing railroad systems throughout a 
country. Practically all public utilities ought to be 
conducted as monopolies. This is usually admitted, 
but the points of dispute arise from questions of owner- 
ship and control. Some discussion of these questions 
will be given later after the student is more familiar 
with the problems of exchange and of labor. 



CHAPTER X 

VALUE 

Meaning of the Term Value — We have already seen 
that there are many meanings which can be under- 
stood from terms used in our study of economics. 
Deahng, as it does, with matters which affect our daily 
lives, economics is bound to borrow its terms from 
common language. But common colloquial language 
is seldom definite. We realize when talking in ordinary 
conversation what is meant by the speakers rather 
than what is meant by the particular words. The 
word value, for instance, has many meanings. When 
we ask what is the value of a certain piece of land, we 
may mean how may it be used ; but we may also mean 
how many dollars are necessary to purchase it. We 
speak of the value of the right to freedom of thought, 
the value of fresh air, the value of good health, the value 
of a loaf of bread or of a piano, and so forth. In speak- 
ing to a doctor, for example, we ask what is the value 
of bread and he will answer in terms of the usefulness 
of bread as food. But when we ask the same question 
of the baker, he will tell us how many cents a loaf costs. 

If we are to use the term with any degree of accuracy, 
it is necessary for us to give it a definition which will 
limit the meaning of the word value in such a way 
that we shall always understand the same idea when 

120 



VALUE 121 

we hear the word. It does not follow that the mean- 
ings which must be exchided are necessarily wrong. 
Obviously this is not the case. But from our point 
of view there are certain aspects which do not affect 
us. In economics we are endeavoring to measure 
motives and laws. We wish to deal with concrete 
matters as much as possible. Hence what we may 
here term the ethical meanings of words are not con- 
sidered. 

In economics, the word value signifies a ratio. It 
means the ratio in which one article exchanges for an-' 
other. If it is found that a pound of coffee exchanges 
readily for half a pound of butter, we say that the value 
of a pound of coffee is equal to that of half a pound of 
butter. That is, we refer to value as value in exchange. 
This is the only sense in which we shall use the term 
in our future discussions. The purpose of the chapters 
which follow is to consider how value is determined 
and how the process of exchange is carried on. That 
is, we must study the reasons which cause variations 
in the ratio of exchange of one commodity for another 
and the mechanism by which such exchanges are made. 

In Chapter IV it was shown that all production was 
production of utilities, and so likewise was all consump- 
tion. In exchange it is exchange of commodities and 
services with which we deal. The exchange will de- 
pend very largely upon the utilities of the commodities 
and services. Utility was defined as the power to 
satisfy wants or desires. A piece of steel shaped so 
that it will cut wood or metal possesses utility only 
because there is a desire for such an article. The serv- 
ices of a doctor or lawyer possess utility because there 



122 AN INTRODUCTION TO ECONOMICS 

is a desire to consume those services. A bottle of 
whisky possesses utihty because there is a desire to 
consume that whisky. 

Diminishing Utility — There are, however, variations 
in the intensity with which these commodities and 
services are desired. For example, if we are very 
thirsty, our demand for some thirst-quenching liquid 
is very strong, but when we have satisfied our thirst 
the desire is much weaker. With each additional 
drink our desire for more water is reduced. In other 
words, the utility of the glass of water diminishes with 
each additional glass. No estimate of the value of 
the first glass can be made if a person is on the verge 
of death from thirst. In a desert where water is of 
paramount importance, the prospector would some- 
times give his last ounce of gold dust for a single drink. 
But let him believe that he can reach the next water- 
hole without a further drink, his desire is reduced con- 
siderably. When he has actually reached the water 
supply, then he will exchange nothing for the drink. 
His wants being satisfied, there is no further utility 
in the water. 

Let us take a further illustration. Most of us have 
a desire at times for coffee. The desire has not the 
same intensity for each of us, however. In an in- 
dividual case a man may so desire coffee that he is 
willing to pay, let us say, ten dollars for a pound of 
coffee. At that price, however, he will content him- 
self with one pound. If the price be reduced to eight 
dollars a pound, he may buy another pound. In this 
case it would seem, therefore, that the utility of the 
first pound of coffee is represented by ten dollars, but 



VALUE 123 

that of the second is only eight dollars. If the price 
be reduced to six dollars, then he will buy another 
pound, showing that the utility of the third pound is 
six dollars. And so the utility of each additional 
pound of coffee falls until a point is reached, let us say, 
at thirty cents a pound when he will buy no more coffee, 
no matter how much further the price be reduced. His 
wants are all satisfied in respect to coffee when the 
price falls to thirty cents. 

This gradual fall in the utility of a given commodity is 
spoken of as the lavj of diminishing utility, and it may 
be expressed as follows. The utilities of additional 
units of any commodity to any consumer tend to fall 
as his supply of that commodity increases. 

As we have seen, however, the element of price enters 
into the question. In our last illustration the utility of 
a single pound of coffee was represented by ten dollars. 
If we tabulate the particulars, we shall have a state- 
ment something like this : 



tE 


Quantity Consumed 


Price 


Quantity Consumed 





1 pound 


$3 


6 pounds 


8 


2 pounds 


2 


7 pounds 


6 


3 pounds 


1 


8 pounds 


5 


4 pounds 


.50 


9 pounds 


4 


5 pounds 


.30 


10 pounds 



Marginal Utility — If the price had gone above ten 
dollars a pound, no coffee would have been bought 
by this particular consumer. But he was willing to 
pay as high as ten dollars for one pound. The dividing 
line between one pound of coffee and none at all is 
represented by the price of ten dollars. This dividing 



124 AN INTRODUCTION TO ECONOMICS 

line is called the margin. The marginal utility of one 
pound of coffee is ten dollars. The marginal utility 
of the second pound is eight dollars ; of the fifth pound 
four dollars, and so on. 

When the price of coffee has fallen to, let us say, two 
dollars a pound, the individual under consideration 
will buy eight pounds. Rather than buy any more 
coffee at that price he will spend his money on some 
other commodity which, he thinks, will yield him more 
satisfaction. The question which he will put to him- 
self, unconsciously, perhaps, is this : " Will there be 
more satisfaction out of an additional pound of coffee 
if I spend another two dollars than if I spend that 
additional two dollars on tea or tobacco?" If he 
decides not to expend another two dollars on coffee, 
then it is plain that the marginal utility of coffee is 
reached at eight pounds. It is true that he would gain 
additional satisfaction from more coffee, but the ad- 
ditional satisfaction would require an expenditure of 
another two dollars and he believes that he could get 
more satisfaction from spending the two dollars on 
something else. 

Present and Future Satisfaction — There is another 
aspect of the question, however, besides that of the 
marginal utility of two different commodities. The 
marginal utility of one commodity at different times 
will vary. If the question is one of immediate satis- 
faction, it is not the same as if the satisfaction is to be 
postponed to the future. Suppose a man wishes to 
buy a box of cigars and the price is ten dollars. He 
wants that box immediately. If he is told that he 
cannot get the cigars until next week, he may think 



VALUE 125 

that it is better worth while to spend the money on 
some present satisfaction unless, perhaps, the tobacco- 
nist offers to let him have the cigars next week at eight 
dollars. In that case he may decide to save eight 
dollars for the cigars and spend the two on immediate 
satisfaction. From which it is clear that the marginal 
utility of a box of cigars to be had immediately is 
greater than that of a similar box for which the pur- 
chaser has to wait. 

In making a decision to purchase anything the ques- 
tion which has to be decided is one of relative marginal 
utility. If the individual above referred to is in doubt 
whether to buy a few cigars or to go to the theater, 
the marginal utility of the one satisfaction is almost 
equal to that of the other and his choice decides which 
has the greater. Of course, the decision is not the re- 
sult of careful thought each time. The mere fact that 
a decision is made shows that to that man at that par- 
ticular time the marginal utility of the one satisfaction 
which he chooses is greater than that of the one he 
rejects. 

The ratio between future and present satisfactions 
varies greatly with peoples and with individuals. 
Children and savages place a very much higher value 
upon present satisfactions than upon future. Races 
of higher culture and individuals of greater intelligence 
make less difference between the two. 

As value is merely a ratio of exchange, in order to 
know the value of any article we have to discover for 
what other article it will exchange. An article cannot 
be said to have value, in the economic sense, of itself. 
There is no such phrase as intrinsic value in economics. 



126 AN INTRODUCTION TO ECONOMICS 

Consequently in any exchange the values of the ex- 
changed articles are equal to one another. If a man 
exchanges a city lot for an automobile, he feels that he i 
is getting something which he desires in place of some- 
thing which he desires somewhat less. The other 
party to the transaction has a similar feeling. The 
difference is not a difference in values, but a difference 
in satisfactions. The owner of the lot would not give 
his lot for the automobile unless he felt that he could 
obtain more satisfaction from the machine. And like- 
wise the owner of the automobile thinks that the lot 
will give him more satisfaction than he obtained from 
his car. Both parties are, therefore, satisfied. 

This refers, however, to individual transactions, and 
it is not with these instances that we are concerned. 
What we desire to find out are the laws which govern 
all exchanges, if there be any such. We have already 
seen in an earlier chapter that utilities are only pro- 
duced to satisfy desires which are either existent or 
latent ; that is, desires which are already well known 
and others which are not known to exist, but are wait- 
ing the utility which will satisfy them and thus call 
them into being. We know, moreover, that in our 
present organization each one of us is a specialist of 
some sort. None of us produces for himself all that 
he requires. There must, therefore, be some means of 
securing the correct distribution, or, at least, the ap- 
proximately correct distribution of the productive 
effort in order that our desires may be met as well as 
they are. 

Effective Demand — It is true that many of our 
desires are not met. The absolutely contented man 



VALUE 127 

does not exist, and if he did, it is doubtful whether he 
would be of any great service to humanity. Civiliza- 
tion does not grow with a diminution in the number of 
wants, but by their increase. But every want does 
not bring forth the necessary production. Something 
more is required than mere desire. There must be 
something produced to exchange for the new produc- 
tion which is to satisfy the want. For example, the un- 
skilled laborer may desire with all his heart to possess 
a limousine.. But that desire will not bring about the 
production of limousines. For in order that the laborer 
may obtain one he must be able to exchange something 
for it, and it is only a remote possibility that he possesses 
any article which the limousine producer is willing to 
accept in exchange. The demand exists, but it is not 
an effective demand. In order to become effective the 
producer of the limousine must be willing to accept 
something in exchange which the laborer is able to 
offer. When we say, therefore, that demand produces 
the supply, or, to be more accurate, that demand causes 
the supply to be produced, we must qualify the word 
demand by considering only the effective demand. 
And there must be a similar qualification in regard to 
supply. A supply of a commodity may exist, but it 
may not be available. The iron ore in the Andes un- 
questionably exists, but it is not an element in the 
supply of iron because it is not worked. 

Meaning of Price — Again, when it is said that the 
ratio at which any commodity exchanges for another 
depends upon the demand for and the supply of the 
commodities, the same restriction in the meaning of 
the two terms must be made. In order to make our 



128 AN INTRODUCTION TO ECONOMICS 

discussion a little more simple we shall speak of ex- 
changes of commodities for money. This, as we shall 
see later on, is merely an intermediate form of exchang- 
ing goods for goods. But for the present purpose the 
ordinary meaning of the word "price will be satisfactory. 
Stated simply, price is the ratio at which a commodity 
or article or service exchanges for money. To repeat 
the statement made at the beginning of this paragraph 
in another form we may say that price is governed 
by supply and demand. This statement is accepted 
commonly, but it is very frequently misused and we 
must be careful to understand all the assumptions that 
are made when the phrase is correctly used. 

Let us take the case of the price of coal for the sake of 
illustration, and consider it first from the point of view 
of the demand. Coal is used for many purposes, — 
fuel for household fires, for steam engines, for gas pro- 
duction, for coke making, and so forth. The general 
demand is very great. But the intensity of the demand 
of the various groups who desire coal varies within 
wide limits. There are some who must have coal at 
all costs, or cease their own production ; as, for example, 
steamship owners, and gas companies. There are 
others who will not have coal unless they can get it 
at a very low price. Between the two extremes there 
are many grades. These grades can best be dis- 
tinguished by the prices they are willing to pay for the 
coal. If coal should be sold only at a price of eighty 
dollars a ton, a great many would-be coal users must 
refuse to purchase. At that price their demand is not 
efi^ective. Some there will be who must have coal and 
who can afford to pay that price. These constitute 



VALUE 129 

only a small portion of the total possible purchasers. 
Now, if the price be reduced to forty dollars a ton, 
there will be an additional group who will now buy 
coal. The reduction in price has made effective an 
additional demand. Let the price fall now to twenty- 
five dollars a ton and the effective demand will be very 
greatly increased. When the price is reduced to five 
dollars a ton, there is an immense increase in the ef- 
fective demand. 

Relations between Supply and Demand, and Price — 
Now turn to the question of the supply. When the 
price is as high as fifty dollars a ton, almost every avail- 
able ton of coal will be offered for sale. The physical 
supply becomes almost the same thing as the effective 
supply. But as the price falls, some of those who have 
a supply of coal will refuse to sell. The lower the 
price, the smaller will be the effective supply, until, 
when the price has reached the point at which the de- 
mand is greatest, the supply is at its lowest limit. We 
may say then, that, as a rule, the lower the price the 
greater the demand and the smaller the supply. 

In the case of commodities which are actual physical 
necessities differences in price will not affect the amount 
demanded except to the extent that possibly some of 
those whose demand is not effective will die and so re- 
duce the possible demand. 

Elasticity of Demand — The difference which a rise 
or fall in price will make to the effective demand will 
vary according to the nature of the commodity. The 
more nearly the commodity approaches to a pliysical 
necessity the less difference will an alteration in price 
effect. We may speak of the possible variations in 



130 AN INTRODUCTION TO ECONOMICS 

demand due to a change in price as the elasticity of 
demand. When a fall in price causes a large increase 
in the effective demand, the demand is said to be elastic. 
When there is little difference caused, the demand is 
inelastic. As a rule we see the greatest elasticity of 
demand in those articles which are luxuries. This is 
naturally so. All of us desire the luxuries as well as the 
necessities of life. We must first satisfy ourselves in 
regard to necessities, but after that we seek the luxuries. 
The reason we do not all succeed in obtaining as large 
a share of the luxuries in life is that our demand is not 
effective. The price is a little above what most of us 
can afford to pay. But a drop in prices will make 
immediately effective a great deal of latent demand. 

There are other causes, however, which affect the 
elasticity of demand. There are hardly any articles 
or goods which can be considered in themselves to be 
absolute physical necessities. Food is a necessity, of 
course, but food is a word which includes in its mean- 
ing many articles, none of which is by itself essential. 
For instance, we may say that wheat is a necessity. In 
so far as it is a source of food we may safely so regard it. 
But if the supply of wheat is only effective at a high 
price, the demand will fall off very largely. This is be- 
cause there are other forms of food which will satisfy 
our needs as well or almost as well as wheat. Con- 
sequently a high price in wheat may cause a very great 
fall in the demand, as the demand for food can be 
satisfied by substituting barley or some other cereal. 
The existence of substitutes, therefore, will tend to 
make an inelastic demand elastic. 

Let us consider once more our illustration of the coal 



VALUE 131 

supply and demand. Coal has, as we have said, many 
uses. Take its use as fuel. In our climate fuel is a 
necessity. If coal were the only form of fuel, it would 
be an absolute physical necessity, and its demand, there- 
fore, would be inelastic. But there exist many other 
forms of fuel. It might happen, for example, that the 
price of coal was high while oil was cheap. The demand 
for coal would be transferred to oil. If we suppose 
that coal is regarded as the best form of fuel, then as 
soon as the price of coal approached that of oil, the 
former oil-users would change to coal, thus increasing 
the demand. Consequently the demand for coal in- 
stead of being inelastic, is elastic. 

In all considerations of the elasticity of demand the 
presence of substitutes must be taken into account. 

The same argument which has just been applied in 
regard to the elasticity of demand applies with equal 
force to the elasticity of supply. The higher the price, 
the greater will be the effective supply, but in the case 
of some commodities a small increase in price will cause 
a large addition to the supply, while in others it takes 
a very considerable rise in price to affect materially 
the supply. In the case of those goods which require 
a large fixed capital to secure efficient production, if 
the actually existing supply is equaled or nearly 
equaled by the demand, it will require a considerable 
rise in price to cause new production. A small rise 
will probably not be sufficient to encourage manu- 
facturers to invest new capital in the manufacture of 
the particular articles in question, but a large increase 
will tempt them to start new factories so as to reap 
some of the profits due to the increase in prices. 



132 AN INTRODUCTION TO ECONOMICS 

At the same time if there are efficient substitutes, 
a small increase in price will tend to encourage the 
manufacture of those substitutes, provided the fixed 
capital required for such production is not so expensive 
as that required for the article itself. 



CHAPTER XI 
THE LAW OF SUPPLY AND DEMAND 

It is frequently asserted that prices are governed by 
the law of supply and demand. In the last chapter 
it was shown that the terms supply and demand were 
not quite so simple as thej'^ would appear to be. Be- 
fore we can understand exactly what is meant by the 
law, we must examine very carefully the theory of the 
competitive system of distribution. That can best 
be done by taking simple illustrations. 

The Factors of Exchange — Suppose there are two 
schoolboys one of whom possesses more oranges than 
he desires and the other a similar superfluity of apples. 
There is here a possibility of an exchange of oranges for 
apples. Let us take first the case of the boy with the 
oranges. He may or he may not want apples. If he 
has no wish for apples, there will be no exchange unless 
he is able to exchange apples for something which he 
does want. Assuming, however, that he does wish to ob- 
tain some apples, the question which arises for him is, how 
many oranges is he to give for how many apples. This 
will depend upon several different factors. His desire 
for apples may be very strong or very weak or medium. 
If he has a passionate fondness for apples, it will tend to 
make him willing to exchange a large number of oranges 
for one apple. If he has only a very slight desire for 

133 



134 AN INTRODUCTION TO ECONOMICS 

apples, he will only give a small number of oranges in 
exchange. If his desire is only medium, then we may to 
a large extent ignore it as a factor in the exchange, and 
turn to the next. He may or he may not be very fond 
of oranges. The higher value he places on oranges the 
fewer is he likely to offer for apples. Again, his supply of 
superfluous oranges may be very large or comparatively 
small. If it is large, there will be a tendency to offer 
more oranges for an apple than if it be small. 

Still further, the number of superfluous apples pos- 
sessed by the other boy may be large, medium, or small. 
If it be large, the boy with the oranges will expect to 
receive a comparatively larger number of apples for his 
oranges, than if it be small. He may know, moreover, 
that the boy with the apples is either very fond of apples 
or not and consequently either unwilling or willing to 
part with this extra store. All of which will affect 
the ratio of exchange. 

So far we have considered only the existence of two 
boys. Let us suppose, however, that there are other 
boys with oranges and apples. This will complicate the 
question, for the fact that there are others willing to ex- 
change oranges for apples will tend to make the original 
party to the exchange modify his terms. If A and B 
possess oranges and C and D apples, A will rather offer a 
few more oranges than B, in order to obtain the apples, 
than let B get them. And the fact that he can obtain 
apples from either C or D will tend to make him offer 
less to C on the ground that if C does not wish to sell 
he can obtain all he wants from D. 

A further complication results from the possibility 
of A and B preferring to satisfy their desire for fruit 



THE LAW OF SUPPLY AND DEMAND 135 

by taking pears rather than paying too many oranges 
for apples. 

We may sum up the factors that enter into the ex- 
change as follows : From the buyer's point of view, 
the factors are these : 

1. The buyer's desire for the other commodity 

2. His desire for the purchasing commodity (apples in our 
illustration) 

3. His supply of purchasing goods 

4. The supply of the other commodity 

5. The desire of the seller for the goods he sells 

6. The desire of the seller for the purchasing goods 

7. The presence of other buyers and sellers in the market 

8. The presence of substitutes 

In the exchange as we have described it, both parties 
are buyers and sellers at the same time. This is es- 
sentially true of all exchanges, no matter how they are 
conducted, so the point of view of him whom we have 
called the buyer in our illustration is the same as the 
seller. In practice, however, unless we are dealing 
with a case of simple barter, which is common among 
schoolboys, the exchange is carried on by means of an 
intermediate commodity which we call money, usually 
a scarce commodity with schoolboys. This, as we 
shall see in a later chapter, does not affect the argument. 

Strong and Weak Buyers and Sellers — When we 
consider a larger market than that implied in the above 
discussion, we shall readily understand that there are 
many ratios of exchange. The governing factors are 
not the same for all of the buyers? nor for all of the 
sellers. One boy may be a strong buyer, that is, his 
desire for oranges may be very strong while his desire 



136 AN INTRODUCTION TO ECONOMICS 

for apples is weak. Another may care very little for 
oranges and a great deal for apples. And similarly 
there may be a difference between the desire on the 
part of the possessors of apples. The quantities of 
oranges possessed by one may not be so great as those 
possessed by others, and so forth. So there may easily 
be exchanges between some of the orange dealers and 
some of the apple sellers and not between others, and 
the ratios of exchange, where exchange actually takes 
place, will not be the same. 

To vary the illustration and to bring in the question 
of price let us recur to the variations in the price of 
coal. As we suggested in the last chapter there are 
some people who must have coal no matter what the 
price is. If the price be very high, however, only those 
who absolutely must have the coal will buy it. When 
the price falls, other buyers whose needs are not quite 
so imperative will purchase coal, and the farther the 
price falls, the more buyers will there be, until all have 
satisfied their desires. 

Let us' suppose that the high price of coal is twenty 
dollars a ton. At that price there are buyers for, say, one 
thousand tons . Should the price fall to fourteen dollars 
there will be purchasers for four thousand tons. We may, 
for the sake of example, tabulate a series of prices with 
the amounts for which there are purchasers, as follows : 



Price op a Ton 


Number 


OF Tons Demanded 


$20 




1000 


14 




4000 


8 




9000 


5 




14,000 


2 




21,000 



THE LAW OF SUPPLY AND DEMAND 



137 



The Demand Curve — This situation may be con- 
veniently studied by means of a graph or curve, as in 
Figure 3. This figure is drawn on paper ruled into 
squares. Following the ruled lines we have two straight 
lines, OX and OY, at right angles to each other, meet- 
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division in the direction OX represents a given number 
of tons, say one thousand. Each division in the direc- 
tion OY represents a price per ton, say one dollar. 

Referring to the table we see that the first price was 
twenty dollars a ton. We therefore count up twenty 
spaces in the direction OY, starting from the point 0. 
The number of tons taken at that price was one thou- 



138 AN INTRODUCTION TO ECONOMICS 

sand. We therefore move one space in a direction 
parallel to OX and there mark a point. The second 
price was fourteen- dollars. We count up toward Y 
fourteen spaces, and, as four thousand tons were taken 
at that figure, we mark our second point four spaces 
along in the direction of X. 

In a similar manner we mark the points correspond- 
ing to the remaining figures in the table. These points 
are obviously not in a straight line. If we join the 
points the result will be a series of short, straight lines. 
But this would indicate that the movement of de- 
mand was jerky, which is hardly probable. If we had 
taken more figures we should have arrived at a further 
series of points filling up the gaps between the five 
points taken and it would appear that the demand, 
moving gradually as the price falls, would follow the 
same general direction as the five points taken, that 
is to say, they would follow a curved line passing 
through the five points. Such a curve we may call 
the demand curve for coal, according to the figures in 
our table. 

If this demand curve truly represents the relation 
between the price of coal and the amount purchasers 
are willing to take, then we may obtain data regarding 
other prices than those in our table. For example, 
suppose the price is eleven dollars a ton. The hori- 
zontal line drawn from the eleventh space touches the 
curve at the sixth vertical line. There will, therefore, 
be a demand for six thousand tons of coal at that price. 
The total price paid for the coal will be represented 
by the rectangle contained by the horizontal and 
vertical lines which touch the curve. In our last ex- 



THE LAW OF SUPPLY AND DEMAND 139 

ample, the rectangle PP'TO represents the amount 
paid for coal at eleven dollars a ton, sixty-six thou- 
sand dollars. 

Consumer's Surplus — Let us suppose that eleven 
dollars is the actual price paid at a given time. Total 
purchases amounting to six thousand tons are taken. 
But the purchasers of one thousand tons out of this 
six thousand would have been willing to pay as high 
as twenty dollars a ton if they had been forced to do 
so. They have made an actual expenditure of eleven 
thousand dollars instead of a possible expenditure of 
twenty thousand dollars. They are, therefore, in 
pocket to the extent of the difference, nine thousand 
dollars. This difference between the amount actually 
paid and the amount that the purchasers would have 
paid rather than forego the use of the coal, is termed 
the consumer s surplus. The total amount of this 
consumer's surplus may be obtained from the figure 
by simply calculating the area inclosed between the 
lines PP', the curve, and PY, taking Y as the point at 
which the curve touches the line OY. 1 J 

It will be noticed that we have carefully refrained 
from using the phrase amount of coal sold, and have 
used instead the expression amount which the pur- 
chasers were willing to take. Because there are pur- 
chasers for a certain amount at a given price it does 
not follow that there are the same number of sellers 
at that price. There will be many more sellers willing 
to part with their coal when the price is twenty dollars 
a ton than when it is ten dollars. As the price falls 
the amount of coal available to purchasers falls also. 
The strong holders will hold their coal until a higher 



140 AN INTRODUCTION TO ECONOMICS 

price obtains, the weaker selling when the price seems 
sufficient to them. 

The Supply Curve — We may tabulate the amount 
of coal available, that is, the effective supply, as we 
did the effective demand. The table below may serve 
as illustration. 



Price of a Ton 


Number 


OP 


Tons Available for Sale 


$ £ 






2000 


5 






14,000 


8 






18,000 


14 






22,000 


20 






24,000 



These figures may be plotted as a curve in a similar 
m.anner to that in which the demand curve was drawn. 
The result is shown in Figure 4. From this curve the 
supply available at different prices can be seen. At 
a price of eleven dollars a ton, for instance, the amount 
available is between twenty thousand and twenty-one 
thousand tons, say twenty thousand, five hundred tons. 

Producer's Surplus — Let us suppose that the price 
is fixed at eight dollars a ton. At that figure the 
amount of coal available is eighteen thousand tons. 
The total price received, therefore, is eighteen thousand 
multiplied by eight dollars, or one hundred and forty- 
four thousand dollars. But there were merchants who 
v/ere willing to sell two thousand tons even if the price 
were as low as two dollars a ton. That is, they would 
have been wilhng to receive four thousand dollars, but 
they actually receive sixteen thousand dollars. The 
additional price received above their minimum is, there- 
fore, twelve thousand dollars which is the producer's 
surplus. There is, of course, a different producer's 



THE LAW OF SUPPLY AND DEMAND 



141 



surplus for each producer, according as the minimum 
at which he will sell his coal varies. The total pro- 
ducer's surplus at any given price may be seen from 
the curve. The area included between the lines OT, 
TP' and the curve 0P\ taking the point as the point 





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where the curve meets the line OX, represents the total 
producer's surplus at the price of eight dollars a ton. 

Market Price — These two curves, however, merely 
represent the variations in supply and demand. The 
question we wish to solve is this : What is the actual 



142 



AN INTRODUCTION TO ECONOMICS 



price at which the coal will be sold under the conditions 
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are any actual sales there must be an equality between 
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This will most readily be seen if one curve is super- 
imposed upon another, as in Figure 5. The curves 
cross one another on the price line of five dollars. At 
that point the demand is for fourteen thousand tons 
and the supply is also fourteen thousand tons. The 
natural assumption, therefore, is that the price at 
which coal will be sold is five dollars a ton. 



THE LAW OF SUPPLY AND DEMAND 143 

Definition of Term " Market " — This price is 
termed the market price of coal. We have used the 
term market several times now without having def- 
initely determined what meaning we give to the term. 
As usual, there are many meanings which may be at- 
tached to the word. A market may mean a building 
in which goods are sold. In the case of a meat market, 
for example, it will depend upon the person who uses 
the term whether he means a building in which meat 
is displayed for sale, or the district in which a man 
may dispose of meat. Sometimes the word is even 
used instead of the word price. It is important that 
we should limit the term to one meaning in order that 
our discussion should be accurate. We must leave 
to colloquial speech the idea of a market being a build- 
ing, or representing a price. In the economic sense 
a market is the area in which all buyers and sellers 
have equal opportunity for obtaining information re- 
garding the demand for, and supply of, a given com- 
modity, and also equal facilities for buying or selling 
that commodity. 

In some cases the market represents a very wide 
area and in others it is very restricted. The wheat 
market, for example, is almost as wide as the world. 
American dealers know the European demand and 
supply ; they know also how much wheat Australia 
and Russia are able to offer for sale, and how much 
they are likely to want for themselves. A similar 
knowledge exists in Europe, Australia, and Russia. 
Wheat is readily bought by Europeans in America or 
in Australia and vice versa, so we have all the con- 
ditions requisite to form a market. On the other hand. 



144 AN INTRODUCTION TO ECONOMICS 

the fresh vegetable market is purely local. No one 
in New York, for example, is interested in the fresh 
vegetable supplies in central California. By the time 
those vegetables could reach New York they would 
cease to be fresh. Hence there is a definitely restricted 
area in which the fresh vegetables may be bought and 
sold. 

In considering the market price it must always be 
remembered that we are not dealing with the results 
of any individual bargain. There are variations in 
the skill at bargaining which will offset some of the 
effects resulting from a pure consideration of supply 
and demand. A weak buyer, for example, may be 
able by his skill to hide his weakness and convey an 
idea of strength to the seller, and so obtain a lower 
price than would otherwise be the case; and the re- 
verse is also true. But these individual variations in 
skill will tend to cancel one another when we consider 
the total sales made. It is not to be expected that 
the bulk of the skill will lie with either the buyers or 
the sellers; it will probably be equally divided be- 
tween both. So the number of weak buyers able to 
hide their weakness will be neutralized by the number 
of weak sellers who convey an impression of strength. 

Limits of Price Fluctuations. Normal Price — 
Market price fluctuates from day to day and, in some 
instances, from hour to hour. Its variations, however, 
have limits Let us take the case of the production of 
automobiles. Here the fluctuations in market price 
are not very wide, but they exist. Now there are 
engaged in the production of motor cars many dif- 
ferent firms, working at varying rates of profit. At 



THE LAW OF SUPPLY AND DEMAND 145 

a given price for a machine of a certain standard of 
quality one firm will make a high profit and another 
will make just sufficient to encourage it to keep on pro- 
ducing. Now as the market price for this particular 
machine falls, it will mean that those firms which were 
working at the minimum profit will cease to produce. 
The new price renders it impossible for them to gain 
the minimum rate. But this will mean a reduction 
in the amount of machines produced, or, in other words, 
a fall in supply. And this in turn will naturally tend 
toward preventing a further fall in price, if not in pro- 
ducing an actual increase in price. 

Again, if the market price should show a tendency 
to a steady rise, the increased profits resulting from 
this rise in price will tempt capitalists to invest new 
capital in the production of similar machines, and hence 
result in an increase in supply. This, in its turn, will 
tend to prevent the further increase in price or even to 
cause a fall. There is, therefore, an upper and a lower 
limit beyond which the market price cannot rise or fall 
for any length of time. For a short period, and owing 
to conditions which are of a temporary nature, it is 
possible for the market price to fall below or to rise 
above these limits, but this is only true for a short 
time. If the fall or rise seems likely to continue, 
then the effects above described will inevitably be 
realized. 

There is, then, a price, or rather a range of prices, at 
which the normal production will be kept up without 
either increase or decrease. This price is termed the 
normal price. Normal price has no effect upon any 
given market price. All that it does is to set a general 



146 AN INTRODUCTION TO ECONOMICS 

limit beyond which market prices cannot fluctuate for 
more than a very short period. 

From this discussion it would appear, therefore, that 
in the long run, prices are determined by cost of pro- 
duction. If the price falls so low that the cost of pro- 
duction is not realized, production will to a certain 
extent cease, and, therefore, supply will be reduced and 
so check the tendency to fall further. If the price 
rises very high above cost of production, new capital 
will come in to produce more goods, so increasing the 
supply and producing a tendency to lower prices. 

The foregoing discussion of the law of supply and 
demand rests upon certain assumptions which are not 
always justified by the actual conditions of exchange. 
First is the assumption that all exchange is carried on 
under conditions of free and unhampered competition. 
This, as we have seen in a previous chapter, is not the 
case. There is no such thing as entirely free competi- 
tion to-day. Any country grocer will readily admit 
that he has to sell certain goods at a price in determin- 
ing which he has had no say. Monopoly after monopoly 
is attempted with the very definite end in view of pre- 
venting a competitive fixing of prices. It is true that 
perfect and absolute monopoly does not exist, but the 
nearer the attempts approach to the ideal, the further 
is the departure from the competitive price fixing under 
the law of supply and demand. The question of 
monopoly price, however, will concern us in the next 
chapter. Here it must merely be noted. 

A second consideration arises in the variations in 
the knowledge of possibilities of cheaper supplies on 
the part of the buyers, or higher prices for the sellers. 



THE LAW OF SUPPLY AND DEMAND 147 

This is realized by advertisers who strive to obtain the 
widest pubhcity for the goods they are trying to sell. 
It is realized that there may be many buyers for these 
goods who do not know of their existence and are buy- 
ing similar goods at a higher price. 

The Flow of Capital — This lack of competition and 
of knowledge as to the conditions of supply and demand 
affects particularly market price, but normal price is 
affected also. Following the purely theoretic discussion 
of the determination of normal price which has been 
given above, it would seem that the moment prices 
rose to a point which permitted of profits above the 
normal rate, new capital would be drawn into the pro- 
duction to take advantage of these increased profits. 
In practice, however, this is not always the case. The 
increased profits may not be general knowledge, and 
those who are reaping them will do all in their power 
to prevent the knowledge becoming general. Hence 
the price may stay above the normal level for a con- 
siderable period. Ultimately, it is bound to be dis- 
covered. But even then the question will arise as to 
whether the increased production will not bring down 
prices below the level necessary for normal profits. 
Capital is said to flow toward industries which yield 
high profits. The flow is not the even flow of a river 
in the lowlands, however. It is more comparable to 
a stream falling down a mountain side. At places it 
forms deep pools which brim over and the water falls 
in a cataract. Like most new streams, too, its speed 
and its variations are greatest also in the early stages 
of industries. A thin trickle of capital flows towards 
the production of some new invention or industry — 



148 AN INTRODUCTION TO ECONOMICS 

like the production of moving pictures, for instance. 
Suddenly the stream tumbles down the mountain side, 
being filled from other sources until the stream of 
capital is broad and deep and the rate of increase 
correspondingly slow. 

All these correctives must be taken into account in 
considering the true working of the law of supply and 
demand. But this does not entirely detract from the 
value of the law. If you take an iron ball and suspend 
it by a string it will, obeying the law of gravity, hang 
in a vertical line drawn to the earth from the point of 
suspension. But if you surround that iron ball with 
a series of electromagnets and constantly vary the 
currents flowing through those magnets the ball will 
be drawn from its position and will constantly vary 
that position as the attracting magnetic force varies 
in each of the magnets. This does not affect the truth 
of the law of gravitation. Similarly, although there 
are many causes operating to deflect and to hide the 
effects of the law of supply and demand, the law is 
constantly working nevertheless. What must be real- 
ized, however, is that to speak in a loose way of the 
law of supply and demand regulating prices is to show 
ignorance of the very many other factors which tend to 
vary the price of commodities both in long and short 
periods. 



CHAPTER XII 
MONOPOLY AND MONOPOLY PRICE 

It has been made sufficiently clear in previous 
chapters that the tendency of modern development 
is towards the elimination of competition. While it 
was true that under free competition there was a 
reasonable prospect of the consumer reaping the im- 
mediate advantages in the shape of reduced prices, it 
has been contended that the ultimate advantage to 
the consumer did not rest with the competitive system. 
The free action of the law of supply and demand in a 
full competitive system tended to reduce prices to a 
level which was barely sufficient to keep production 
going on. Manufacture was too close to the margin 
of productivity. That is to say, each of the manu- 
facturers was working, or tended to work, too close to 
that point at which profits disappeared, and so there 
was always the possibility that some few or many 
would be compelled to drop out of business. 

Importance of Stability of Prices — It is to the 
general advantage of the consumer that prices should 
be maintained at a steady level. In the long run this 
is best, even if the level of prices be rather high. This 
question of stability of prices is one with which we 
shall deal later on in the discussion of the relation of 
money to prices. At present it should be noted that 
when a person contracts to do a certain piece of work 

149 



150 AN INTRODUCTION TO ECONOMICS 

it is absolutely essential that lie should know what 
prices he must pay for his materials. If these prices 
are constantly fluctuating, as they undoubtedly would 
fluctuate under the free play of the law of supply and 
demand, it makes the work of estimating costs ex- 
tremely difficult, and as a rule the contractor will feel 
bound to protect himself by estimating upon the safe 
side, that is, by charging higher prices. Whether we 
believe monopoly in general to be good or bad, how- 
ever, we have to admit the fact that the tendency 
toward this form of organization exists, and it remains 
for us, at present, to examine its nature. 

The great evils which the protagonists of monopoly 
organization declare to result from competition may 
be summed up in very few words — low prices and 
waste. From the point of view of the consumer, pro- 
vided production is maintained, low prices are any- 
thing but an evil. On the other hand, waste is an evil 
from whatever point of view it may be taken. Ad- 
mitting, for the sake of the argument, that low prices 
tend to cause restriction of production, we may admit 
the possibihty that monopolistic organization secures an 
improvement. But that very admission constitutes 
the fundamental criticism of monopohes, the criticism 
that they raise prices. 

High prices cannot be maintained, however, unless 
there is some restriction in the free play of competition, 
so there is evidently a close connection between monopo- 
lies and restriction of competition. The term itself, 
taken in its strict interpretation, signifies the entire 
absence of competition. This is seldom realized in 
practice, however, but it is approximated and we may 



MONOPOLY AND MONOPOLY PRICE 151 

use the term in a somewhat looser sense without damage 
to our argument. 

Varieties of Monopolies — Monopolies are of various 
kinds. There are temporary monopolies as contrasted 
with those which have a relatively permanent exist- 
ence. There are monopoHes granted expressly by 
government as a reward for services or as a protection 
against unfair treatment, and those which have been 
brought about by agreement between private indi- 
viduals or corporations. We may deal with the least 
important first. 

Monopolies by Royal Grant — The advantage of 
being the only person who can deal in a commodity 
is obvious, and it was no less obvious in the Middle 
Ages. Kings and dukes were wont to grant rights of 
monopoly to favorites to the great enrichment of the 
latter, and to the still greater disgust of their subjects. 
Even Queen Elizabeth, who was probably as popular 
a monarch as ever lived, had to give way to the de- 
mands of the people for the removal of this kind of 
monopoly. The monopoly of selling salt, for instance, 
weighed heavily upon a people who had no other means 
of preserving meat than by salting. A high price, and 
those medieval monopolists were never very delicate 
in their price manipulations, might easily mean ruin. 
Such monopolies have now ceased, although no doubt 
there are courtiers yet who wish they were still possible. 

Patents and Copyrights — This does not mean, how- 
ever, that governments have ceased to grant monopolies. 
Every civilized country has a system of monopolies con- 
trolled by the government through the patent laws. 
A patent is nothing more nor less than a monopoly 



152 AN INTRODUCTION TO ECONOMICS 

right of production and sale. The argument is this. 
An inventor or author or dramatist has given of his 
time and thought, and possibly of his money also, to 
the production of a new instrument or book or play. 
In so doing he has rendered a service of more or less 
value to the community, and the community should 
pay for that service to the person who rendered it. 
In the case of the invention of a new machine, the 
government says, in effect, here is a new machine 
which may or may not be valuable. If it is, those who 
find it so ought to pay the inventor for discovering it. 
The only way to find out whether it is valuable is to 
try it out in use. Let the inventor have the sole right 
of manufacturing and selling this machine. If the 
public finds it valuable, it will pay. If it should be a 
useful machine, it would not be fair to allow any one 
who so wished to manufacture it and to reap the re- 
ward due to the inventor. In order to protect the 
public from extortion on the part of the inventor and 
at the same time reap the fruits of the effort of his 
brains, the exclusive right is limited to a term of years. 

The same is true of an author. He writes a book 
which the public may buy if it wishes. If it should 
prove a success, that is, if the public should demand the 
book in large numbers, it would be unfair to allow any 
printer who so desired to print cheap copies and cir- 
culate them by selling at a comparatively low price, 
thus preventing the author from receiving the reward 
due to his labor. 

These monopolies are rightly limited in time, how- 
ever. For it is manifestly unfair that a man's heirs in 
perpetuity should keep on receiving a reward for the 



MONOPOLY AND MONOPOLY PRICE 153 

deeds of their ancestor. It is not only the inventor 
or author himself who must be protected, however. 
The inventor may be quite willing to forego any rights 
of his own. Herbert Spencer, the great philosopher, 
found this out through personal experience. He was 
a lover of music and was annoyed at the unsatisfactory 
clips on the music stands which he used. So he in- 
vented one of his own which proved perfectly satis- 
factory. He did not want to make any money out 
of the idea, but when he tried to find a manufacturer 
to produce the clip so that other music lovers could 
avoid a similar annoyance, he found that the manu- 
facturer insisted on a patent being taken out. If there 
were no patent, the manufacturer claimed that he 
would not be able to gain a reasonable profit on the 
risk that he ran, for should the clip prove a failure the 
loss would be all his own, and should it prove a success 
other manufacturers would step in and take away a 
great part of his sales. 

Trade Marks — Another form of monopoly is worth 
mentioning before we treat of the form to which the 
term is commonly applied. Governments in most 
countries provide for the exclusive use of trade marks. 
The owner of a trade mark has the sole use of that 
particular sign with which to mark his goods. This is 
a protection to him and is very rightly given as such. 
If a firm has spent a great deal of trouble building up 
a business which is recognized as a sound one, in pro- 
ducing goods which win popular approval, or has gone 
to great expense in advertising these goods, it is hardly 
fair that it should be deprived of the fruits of that 
labor and expense. In order to distinguish its goods 



154 AN INTRODUCTION TO ECONOMICS 

from those sold by competitors, a firm marks those 
goods by some distinguishing sign or name, by which 
they become well known as the reputation of the pro- 
ducer grows. If there were no provision for copy- 
righting the distinguishing sign, other merchants or 
manufacturers might use it for their own productions 
and thus sell goods to consumers on the reputation 
gained by their more successful competitor. 

A soap company, for example, may manufacture a 
soap which they call " Imperial." If the public de- 
cides that this is a good soap they will buy it steadily, 
and gradually the name will become familiar as repre- 
senting a desirable variety. Realizing that consumers 
are in the habit of asking for " Imperial " soap an- 
other manufacturer might label his production " Im- 
perial " also and so sell large quantities to those who 
thought they were getting the goods manufactured by 
his rival. This is so manifestly unfair that trade marks 
may be registered and copyrighted, and the owners 
are protected against the use of their trade mark or 
one so similar as to be easily confused with it. 

This form of exclusive use, however, is not true 
monopoly. For while the Imperial Soap Company 
has the exclusive right to the use of the word " Im- 
perial " it has no exclusive right to the manufacture 
of soap. Competition still exists and the Imperial 
Soap must take its chance with the Regal and the Re- 
pubhcan and all the other possible brands. 

Monopoly of Location — Nor is the sole right to 
have a store in a certain district rightly to be construed 
as a monopoly. It is true that it eliminates a certain 
amount of competition, but the effect of competition 



MONOPOLY AND MONOPOLY PRICE 155 

from outside the monopoly district is bound to be 
felt. If this particular store charges too high a 
price, its customers can go outside the district for 
their goods. 

If the area be so wide, however, that it is extremely 
difficult for customers to go outside, then the monopoly 
tends to be more absolute. This is because it has a 
better control of price-making. It can raise its prices 
with less likelihood of customers buying elsewhere. 
Now in every one of the cases we have taken, it is ob- 
vious that what is being sought is this very power of 
fixing prices without being subjected to competition. 
This is the essence of monopoly. But there is more 
to be considered before we are able to give a clear- 
cut definition. Even if the power to fix prices inde- 
pendently of the law of supply and demand exists for a 
time, that time will be limited unless there is a certain 
minimum of control of production, as well as of dis- 
tribution of the monopoly goods. 

Necessity of Control of Production and Distribu- 
tion — If there is no control of production, but only 
of distribution, there cannot be permanent control of 
price-fixing, as far as the distributors are concerned, 
for the producers may so raise their prices that the 
profits of high retail prices will not be reaped by the 
distributors. In order that the monopoly should have 
a chance of real success, there should be some measure 
of control of production also. In this way there is a 
unity which the purely distributing side could not pos- 
sess. This has been felt in a great many of the 
monopolies which exist at present. The steel monopoly, 
for example, means not merely the control of the selling 



156 AN INTRODUCTION TO ECONOMICS 

of steel, but also the more or less absolute control of 
the ore beds, of the rolling mills, and of the railroads. 

Definition of Monopoly — This qualification, how- 
ever, merely emphasizes the nature of the control 
necessary before those engaged in a business can have 
the power to exercise definite control over price. We 
may, therefore, define a monopoly as a business group 
which has such unity of producing and distributing 
organization as gives it power to fix prices without 
reference to competition. 

It is the aim of every monopoly so to charge for the 
goods it produces as to reap the maximum profit. 
This does not necessarily mean an increase in price. 
It may happen, for example, that the greatest profit 
can be obtained by selling large quantities at com- 
paratively low^ prices. The cost of production for a 
monopoly organization should be, and often is, less than 
that of competing manufacturers. In competitive 
production there is commonly a great deal of waste, 
both of effort and material. This is evidenced by the 
fact that in many cases, upon the formation of a 
monopoly, several of the former competing plants 
have been shut down without any lessening of the 
supply of the product. Before the formation of the 
monopoly organization most of the factories had been 
working at somewhat less than their capacity. When 
the monopoly was formed all the factories actually 
engaged in producing were working at full capacity, 
while the less eflficient were shut down. 

With this economy of production, therefore, it is 
possible for the monopoly to charge lower prices and 
still reap a greater total profit than that gained by the 



MONOPOLY AND MONOPOLY PRICE 157 

competing firms. It does not follow, however, that 
the monopoly is satisfied with such a gain. If it can 
obtain higher profits by increasing the prices, prices 
will be increased. It is claimed for the Standard Oil 
Company that the prices charged for oil under its 
organization are less than formerly. This is probably 
true. But since the formation of the Standard Oil 
Company there have been many improvements in the 
method of manufacturing fuel and illuminating oil, 
and the probability is, that if competition still existed 
the price would be considerably lower than that charged 
by the Standard Oil Company. 

Factors in Determination of Monopoly Price — The 
problem of fixing a monopoly price is not simple. 
There are many factors to be considered. The nature 
of the demand for the particular commodity must 
first be dealt with. If the demand is very intense it 
may be possible to fix a high price. Too high a price, 
however, will in any case reduce demand. The opera- 
tors who made a famous " corner " in copper discovered 
this to their cost. For a short time they gained ab- 
solute control of the supply of copper, and at once 
raised the price to such a level that the consumers 
simply ceased to consume copper. There were no 
buyers. The corner collapsed in consequence, for the 
operators could not control the necessary capital to 
hold on long enough. Had they been satisfied with 
a more moderate price, they might have made immense 
profits. 

Latent Competition — A very high price, long main- 
tained, encourages competition. It is true that if the 
monopoly is suflSciently strong it may crush such com- 



158 AN INTRODUCTION TO ECONOMICS 

petition, but only at the expense of temporarily re- 
ducing prices. Therefore what may be termed latent 
competition has an influence on the price fixed by the 
monopoly. 

Elasticity of Demand — Apart from the ever-present 
possibility of competition, the important factor to be 
considered is the nature of the demand. Some com- 
modities have a very wide demand, as, for example, 
those which are of everyday use. In these cases, the 
greatest profit is gained through the widest possible 
sale. This means a comparatively low price. In the 
case of the manufacture and sale of soap a very high 
price will cause a large falling off in sales. To sell 
soap for, say, a dollar a cake, may be perfectly possible 
if the monopoly is strong. But at that price a great 
many possible buyers will decide to do without soap 
and regard it as an expensive luxury. Reduce the 
price to twenty-five cents a cake and the sales will 
multiply much more than fourfold. If we assume, 
as we may quite safely, that the increased purchases 
amount to ten times those at the higher price we may 
estimate the profits made. Suppose the cost of a cake 
of soap is ten cents to the manufacturer, inclusive of 
all distributing costs. The profit on the sale of one 
cake is ninety cents, at the price of one dollar a cake. 
But the profits made by selling ten cakes at twenty- 
five cents amount to one dollar and a half. 

It must also be noted that almost invariably the 
unit cost of production is lessened when the quantity 
produced is increased. So we safely reason that in 
the case of the reduced sale at a high price the cost 
of the single cake of soap is considerably higher than 



MONOPOLY AND MONOPOLY PRICE 159 

when the larger quantity is produced for the wide 
market at twenty -five cents. 

It would seem, therefore, that in such cases the 
tendency of a scientifically conducted monopoly would 
be to lower, rather than to increase prices. Few 
monopolies are so scientifically conducted, however, 
and even where prices have been lowered, as we have 
already said, the prices are probably not as low as they 
would be under competition, provided the production 
and distribution were efficiently managed. In other 
words, the facts in regard to monopoly prices support 
the common belief that monopoly price is synonymous 
with high price. 

Note. In this chapter the word production, as distin- 
guished from distribution, is used in the ordinary colloquial 
sense, and not with the meaning given to the term by earlier 
definition. Of course, speaking accurately, distribution is a 
form of production. 



CHAPTER XIII 

THE EVOLUTION OF MONEY 

One of the most difficult facts for students to re- 
member in connection with problems of exchange is 
that all commerce consists merely in the exchange of 
goods or services for goods or services, that is, in the 
exchange of utilities. We speak so commonly of ex- 
changing money for goods that we are inclined to for- 
get that money is merely an intermediary in the matter 
of exchange. When we buy a pound of butter at a 
grocery store we pay, let us say, sixty cents. The 
sixty cents are then used by the grocer to buy, possibly, 
a pound of meat. In reality what has happened is 
that there has been an exchange of butter for meat. 
Money has intervened to facilitate the transaction. 

In order to obtain a clear idea of the nature of 
money it will be well to study the simple transactions 
before money was invented. Every schoolboy has 
taken part in such transactions, for money, as a rule, 
is a scarce commodity with schoolboys, although ex- 
changes are common enough. In these transactions 
it is perfectly obvious that the exchange is one of goods 
alone, with no intermediary. A knife is traded for a 
baseball bat, which may in turn be traded for a bird's 
nest with a few eggs in it, or for a supply of foreign 
stamps or some such article. The problems to be solved 
are comparatively simple as the number of exchange- 

160 



THE EVOLUTION OF MONEY 161 

able commodities is small. In this respect the school- 
boy's commerce is not unlike that of primitive man. 
In primitive times few articles were produced which 
were subject to exchange, and hence exchanges could 
readily take place, although with some difficulty. 
This difficulty can be seen in a modern instance. 

Problems of Barter Exchange — The advertise- 
ment columns of almost any newspaper will show that 
some one is desirous of exchanging an automobile for a 
city lot. Let us suppose that some individual, whom 
we will call John Smith, wishes to exchange his ma- 
chine for a city lot. He must first find some other 
person who has a city lot which he wishes to get rid 
of. There is never much difficulty in finding such an 
individual. But it is not every lot-owner who will be 
satisfactory. He must not only be willing to dispose 
of his lot, but he must want an automobile in exchange. 
This reduces the number of lot-owners who can deal 
with John Smith. Still further the city lot must be 
one which Smith considers equal to. or greater in value 
than his automobile and the owner of the lot must be 
satisfied with Smith's machine. With each condition 
to be satisfied there is a corresponding reduction in the 
number of people who can trade with Smith. 

Every transaction of this sort, which is called barter, 
is subject to all the difficulties mentioned. To carry 
out our modern commerce on this basis is obviously 
impossible. Even in the cases advertised in the news- 
papers, the probability is that when the settlement 
is arrived at, there is a balance in money paid by one 
or the other of the parties. Now, when money did not 
exist, the exchange had to be kept to the two articles 



162 AN INTRODUCTION TO ECONOMICS 

and to them alone. Suppose an Indian makes a 
specialty of producing arrowheads. He must exchange 
most of those he makes for food or clothing or shelter. 
Probably he takes in exchange some furs from animals 
caught by the hunter, who desires a fresh supply of 
arrowheads. It is quite conceivable, however, that 
the arrow maker has sufficient furs for his needs and 
wants something else, say a new supply of dried buffalo- 
meat. If the hunter cannot offer this meat, the ex- 
change will not take place. This leaves both hunter and 
arrow maker unsatisfied. Obviously, what is required 
is some commodity which is desired by every one. 

Cattle Used as Money — In primitive times this 
one commodity existed, just as it does to-day, although 
it is not the same commodity. Food was wanted by 
all, and any one who possessed a store greater than he 
needed for his own use could always exchange some of 
his surplus for other articles. The form which this 
commodity took was usually the living cattle. Prices 
were made in terms of head of cattle. To show how 
intimately the cattle form of money is connected with 
our earlier stages of development, it is sufficient to 
consider the etymology of some of our money terms. 
The word " cattle," for example, is derived from the 
Latin, caput, a head. The word " chattel " is of 
similar origin, and so is the term "capital" which is so 
closely associated in common language with money. 
Again the Latin word for a flock or herd is pecus, from 
which is derived the Latin for money, pecunia. 

Another word which commonly denotes a payment 
of money is the word " fee," which is derived from the 
Anglo-Saxon feoh, meaning either cattle or money. 



THE EVOLUTION OF MONEY' 163 

Other etymological illustrations might be given from 
other languages, all pointing to the same elementary 
fact, but the above will be sufficient. 

Other Forms of Money — Apart from articles of 
food, those which are desirable for purposes of cloth- 
ing or ornament have been used as money. In the 
early years of the colonization of America, skins were 
commonly used for the purpose of exchange, just as 
they were, apparently, among the Israelites. The 
well-known quotation from Job, skin for skin, yea, all 
that a man hath will he give for his life, seems to indi- 
cate that skins were used in facilitating exchange. The 
American Indians used strings of beads, or wampum 
belts, as money. The list of articles which have been 
so used is almost inexhaustible, including feathers, 
furs, oil, fruits, shells, grain, and so forth. 

All these different articles were not uniformly satis- 
factory for the purpose of exchange. Each involved 
certain difficulties, and we can best appreciate these 
difficulties by enumerating the qualities which are 
necessary for a good money material. 

The Qualities Desirable in a Money Material. 
I. Value in Use — Of absolute importance is the 
necessity that such money material should have a 
value in use, apart from its value as a means of exchange 
or a measure of value. All the articles named above 
possess this quality. Cattle, grain, oil are useful for 
food ; furs and skins, for clothing ; beads, shells, 
feathers, for ornament. This quality is essential, but 
there are many forms of goods which, although they 
possess the quality of satisfying some desire, are not 
fit for purposes of exchange. 



164 AN INTRODUCTION TO ECONOMICS 

2. Universal Acceptability — The second quality is 
that of universal acceptability. It is not sufficient for 
one or two persons to desire the article. It must be 
desired by every one. If a professor of geology were 
to write an article for a geological magazine and the 
editor offered him, in payment, an extremely rare fossil, 
it is probable that the geologist would willingly accept 
it. But if that professor offered the fossil to the 
plumber for repairing the plumbing in his bathroom, 
there is little doubt as to the attitude the plumber 
would take. In primitive times the payment would 
be made in one of the articles we have named, or some- 
thing similar. 

3. Divisibility — All exchanges are not of the same 
magnitude, however. It might still be possible to 
use a herd of cows in payment for part of a ranch, for 
instance. But if cattle were the only money substance 
it would be very difficult to buy a box of candy, or to 
pay for a street-car ride. These are extreme instances, 
of course, but the principle is important. To be really 
satisfactory, the money commodity should be capable 
of being divided into small portions for small exchanges. 
It must, therefore, possess the quality of divisibility. 

There are many substances which possess all of the 
above attributes and yet which lack another necessity 
of a good money commodity. In regard to the last- 
mentioned quality — divisibility — there are difficulties 
with certain easily divisible objects. Precious stones 
have sometimes been used as money, and every one 
knows that precious stones are divisible.. But in 
dividing a stone we lose some of its value. If we take 
a ten carat diamond, for example, and divide it into 



THE EVOLUTION OF MONEY 165 

two diamonds of five carats each, the value of the two 
diamonds together will not equal that of the original 
stone from which they were cut. Size itself is an ele- 
ment in the value of the precious stone. In order to 
be satisfactory, therefore, the commodity should not 
only be divisible, but should not suffer any loss in value 
by being divided. 

4. Homogeneity — Another difiiculty arises in con- 
nection with the use of certain substances which can 
be divided. In the case of skin-money, for example, 
it is quite possible to cut the skin into two parts, each 
of which weighs half of the original skin. But the 
value of one part is not the same as that of another. 
The half which contains the head may be used as an 
ornament; at least, some people consider the stuffed 
head of an animal an ornament. The other half is 
practically worthless. Again, in the case of dead cattle, 
if the animal is so divided that one part containing 
most of the bones weighs as much as the other part 
containing most of the meat, the values of the two 
parts are by no means equal. This is also the case 
with the living cattle. A buyer will try to pay with 
the poorest of his herds and a seller will stipulate for 
the fattest of the animals. Indeed the laws of old 
Egypt expressly stated that thin cattle would not be 
accepted in payment of taxes. Government, even in 
those early times, knew enough not to accept cheap 
money. From this difficulty we see that another 
quality is necessary in the material to be used as money. 
It must be homogeneous. That is, it must lose nothing 
of its characteristics by being divided into small por- 
tions. One part by weight should be exactly equal to 



166 AN INTRODUCTION TO ECONOMICS 

another part of the same weight. And not only so, 
but when a piece of the material is divided into two 
equal parts, the sum of the values of the parts should 
equal the value of the original piece. Precious stones 
are undoubtedly homogeneous. A diamond is simply 
a piece of crystalline carbon and it does not cease to be 
so when cut into smaller pieces. But as size is an ele- 
ment in its value it cannot be used satisfactorily. 

5. Portability — The next quality which we find to 
be desirable is that of portability. Some forms of 
goods which answer satisfactorily all of the require- 
ments enumerated so far are unsatisfactory in that 
they can only be transported at comparatively great 
expense. It is true that cattle may be regarded as 
portable in that they carry themselves, but they do not 
do so without expense. The further they have to be 
transported the greater is the cost in time for their 
care, and in food for their support on the journey. 
Hence if the cattle are to be used as a payment for 
goods bought from some person who lives a considerable 
distance away, the expense of transportation may be 
so great as to make the purchase not worth while. 

Even some of the early forms of metallic money were 
not free from this defect. At the present time, as we 
shall see in a later chapter, gold itself is expensive to 
transport, and the, cost of transportation has a material 
influence upon the value of the metal. 

6. Durability — If we suppose that a herd of cattle 
has been accepted in payment of a certain purchase and 
has to be transported for a distance before reaching the 
seller of the goods, there may be more diflficulties en- 
countered than even the expense of feeding and caring 



THE EVOLUTION OF MONEY 167 

for the cattle on the journey. If they have to traverse 
a country which has only sparse pasture or in which 
water is lacking, it is quite possible that the cattle will 
deteriorate very greatly during the journey. Some 
will die and will be worth practically nothing even if 
the carcasses can be carried to the end of the journey. 
Again, if eggs happen to be the money material and 
any length of time elapses between the bargain and 
the payment, it is quite within the bounds of possi- 
bility that the eggs will lose in flavor before they reach 
their final owner. A quality to be desired in our money 
commodity, therefore, is that of durability without loss 
of value. 

There is no commodity which is absolutely durable, 
in the sense that it cannot wear out. But there are 
undoubted degrees of durability, and if one commod- 
ity satisfies most of the requirements for use as money 
and is also fairly durable in use, it is so much the 
more to be desired. 

7. Stability — Then there arises the question of the 
stability of value of the commodity. We have already 
shown some of the influences which are exerted in the 
determination of value, and of those influences one of 
the most important is that of supply. Other things 
being equal, we may say that the greater the supply 
the less is the value of the commodity. Now, if the 
supply of a commodity varies within wide limits, the 
probability is that its value will also vary. A money 
commodity is used not only as a means of exchange, 
but also as a measure of value. For the sake of sim- 
plicity we are accustomed to estimate the values of 
different goods according to the amount of the money 



168 AN INTRODUCTION TO ECONOMICS 

commodity for which they will be exchanged. If the 
money commodity is constantly fluctuating in value 
itself, it becomes almost useless as a measure of value. 
Suppose we use wheat as the money material. One 
day the worth of a bushel of wheat may be represented 
as a couple of pounds of butter or five pounds of coffee 
or half a dozen watermelons. Now if we say that two 
pounds of butter are worth a bushel of wheat we are 
stating the price of butter in terms of wheat. If the 
value of wheat, owing to a sudden increase in the avail- 
able supply, suddenly falls, the exchanges will not 
take place in the same ratio. Hence two pounds of 
butter will no longer be equal in value to a bushel of 
wheat; they will be greater. Similarly the values 
of the coffee and melons will be altered when stated 
in terms of wheat. Hence it is always advisable to 
choose a commodity which does not vary much in 
value from time to time. 

8. Cognizability — The final quality which we shall 
consider as an element in the money material is that 
of cognizability. The money should be easily recog- 
nized for what it is without any undue investigation 
into its character. A little thought on the conditions 
of our present money supply will show the reasonable- 
ness of this requirement. We become at once sus- 
picious of any money with which we are not familiar. 
The familiar money we know and can recognize; the 
unfamiliar we must scrutinize carefully. There are 
parts of the United States where the use of coined 
money is much greater than in others where paper 
equivalents are more frequently seen. The paper is 
scrutinized more carefully in those districts where its 



THE EVOLUTION OF MONEY 169 

use is not so frequent than in those where it is common, 
and vice versa. 

Before we consider what is the basis of the modern 
money materials it will be well to sum up in tabulated 
form the requirements of a perfect money material. 

1. Commodity Value 

2. Acceptability 

3. Divisibility 

4. Homogeneity 

5. Portability 

6. Durability 

7. Stability 

8. Cognizability 

Metals as Money — Of all substances which have 
been used at different times as money the metals 
possess the above attributes in the greatest degree. 
At all times the metals have been desired for their own 
value apart from any uses as measures of value or means 
of exchange. At first, probably, they were used as 
ornament, and later on came their use in industry and 
for weapons of war. There was hardly ever a time 
when metals were not generally acceptable. They 
possess the quality of divisibility, without loss of value, 
in a high degree. A piece of copper which weighs a 
pound is of the same value as two pieces which weigh 
half a pound each. And one piece of copper is exactly 
the same as another piece of the same weight. It is 
homogeneous. The metals are portable also, with 
comparatively small expense. It is true that to use 
the older Greek iron money for modern payments and 
with our present valuation of iron, would involve high 



170 AN INTRODUCTION TO ECONOMICS 

costs for transportation of any considerable sum. 
That would not hold good in the days of iron money, 
for its value was much greater then than now. The 
metals are exceptionally durable also, although there 
are, of course, variations in their degrees of durability. 
Iron money is not so durable as copper if continually 
exposed to the elements. Copper on the other hand 
will wear out by friction quicker than iron. Gold and 
silver also are soft metals and liable to lose by constant 
use some of their weight. No commodity is per- 
manently durable, however, and consequently all we 
can ask is a comparatively high degree of durability, 
and that is possessed generally by the metals. Again 
it may be said that no material is absolutely stable in 
value. But the fluctuations of metals are, taking 
everything into consideration, less than most other 
materials. Finally, especially in primitive times, the 
metals were easily recognized. 

Remedies for Defects in Metallic Money — It is in 
the last three qualities that the metals are least satis- 
factory, especially the common money metals, gold, 
silver, and copper. But much can be done to remedy 
their defects in these respects. In regard to dura- 
bility, for example, while it is true that gold is par- 
ticularly liable, when pure, to loss from friction in 
use, it can be made much less so by the admixture of a 
small proportion of cheaper metal, without thereby 
losing much in value. The alloys of gold are much 
harder and so less liable to loss from wear than is 
pure gold. The same is true of the other metals. 
Hence we do not, in our coinage, use pure gold or pure 
copper. 



THE EVOLUTION OF MONEY 171 

Coined Money — The greatest advantage of our 
modern coined money is, however, its cognizabiHty. 
There are many cheap imitations of gold and of silver 
which might easily pass with the unsophisticated for 
the real article. Even in America people have been 
known to accept " gold bricks " in the belief that they 
were pure gold. This fact of the possible imitation 
and also the variations in the amount of " base " metal 
used in the alloys have made it necessary that there 
should be some indication, on the metal itself, of the 
nature of its purity. 

The development of the imprinting of some stamp 
on the surface of a piece of metal, by some person 
whose reputation was good, has resulted in the evo- 
lution of the modern coin. Originally, probably some 
king or duke or other person in authority placed his 
seal on the flat piece of metal, thereby indicating 
that it was of standard purity. The seal would not, 
at first, cover the entire surface of the piece of metal, 
and partly through wear and tear, and partly through 
the efforts of early economically minded merchants, 
the surplus metal outside the seal would tend to be 
gradually , removed, and before long the shape would 
approximate to that of the seal. In order to avoid such 
loss by clipping, at any rate, the habit grew of making 
the metal the same size and shape as the seal, and as the 
ultimate shape of any flat piece of metal, constantly 
used, tends to be circular, so these pieces of metal came 
to be made circular. In order to prevent filing of the 
edges the latter were "milled" or some design was 
stamped upon them so that any attempts at filing would 
be obvious. 



172 AN INTRODUCTION TO ECONOMICS 

Definition of a Coin — Now all this work placed 
on the metal was made necessary only by the desire to 
make it cognizable for what it purported to be, that 
is, a piece of metal of a standard weight and fineness. 
And that is all that a coin is. To define a coin, then, 
we may say that it is a piece of metal upon whose 
surfaces have been placed stamps or designs by some 
one in authority, the designs indicating that the metal 
is of a certain weight and purity. Because it is shaped 
in this way it does not lose its characteristics as a com- 
modity. It is essential that these should still exist 
in order to satisfy the requirements which we have 
studied in the earlier part of this chapter. 

Debasement of Coinage — It is obviously of great 
importance that the stamp placed upon the coin should 
be placed by a person whose reputation is good. No 
one would place any reliance upon the certificate of 
value issued by an unknown merchant. It might be 
good, but, on the other hand, it might not. In feudal 
times the right of coinage rested in the hands of the 
feudal barons, except when the king retained the sole 
right himself. Unfortunately for the subjects, the 
king did not always justify their faith in his certificates. 
Just as it is possible for a commercial company to 
cheat the public by selling adulterated goods, at least 
for a certain time, so was it possible for kings to adulter- 
ate their money, by increasing the proportion of base 
metal in the coin. There would appear to be a certain 
advantage to the king in so doing, in that he seemed to 
be getting a coin which was of greater value as a coin 
than as metal. But the advantage was only temporary, 
and its consequences were serious to the people who 



THE EVOLUTION OF MONEY 173 

were compelled to use the coinage, especially if they 
were poor. It soon becomes known if the coins are 
being depreciated, and the more intelligent merchants 
then realize that the commodity value has been re- 
duced and hence the ratio at which they will exchange 
their goods for this money decreases. If a certain coin 
of full fineness is worth a bushel of wheat, then the 
coin which is not of full fineness will not be accepted 
in payment of a whole bushel. If the coin is suf- 
ficiently depreciated, it will buy only half a bushel. 
But as the name of the coin, whether it be crown, noble, 
pound, or dollar, remains the same, the number of coins 
to be paid for the bushel of wheat is now two. In 
other words, the price of wheat has been doubled. 
And the case is similar with other commodities. 

Effects of Depreciated Coinage — The effect of a 
depreciation in the coinage, therefore, is at first a rise 
in prices. But if the amount of depreciation is not 
the same with each coin, the tendency arises for the 
stamp on the coin to be disregarded entirely and the 
coin is accepted by merchants only upon an assay, and 
then by weight of the pure metal calculated according 
to the results of the assay. Even the government 
itself sometimes refused to accept at face value for 
taxes the coinage in circulation. At one period of 
English history, when the coinage was considerably 
debased, the face value of the coins was ignored by the 
government tax collectors. When the sheriffs brought 
to the exchequer the sacks of coin in payment of the 
tax levies on their districts, the actual commodity 
value of the coinage was tested by an assay of a sample 
of the coins. Part of the sacks of coin was tested and 



174 AN INTRODUCTION TO ECONOMICS 

the whole of the sacks averaged according to the results 
of the assay. The bulk was then weighed and the 
taxes paid by the weight of gold contained in the sacks. 
The merchants who received payments in large 
amounts, received payment by weight and not by 
" tale," that is, by nominal value. The poorer classes 
were compelled to receive their payments of wages 
by tale and, as the depreciation caused increase of 
prices, the actual amount of goods that they received 
as a return'for their services (what we shall later term 
" real wages ") was very much reduced. 



CHAPTER XIV 
SOME MONEY PROBLEMS 

Seigniorage — The coinage of money is not con- 
ducted without expense. In the feudal days, when the 
right of coinage was confined to the lord of the manor, 
or the seignior, it was customary for the latter to 
charge a certain amount to pay for the cost of turning 
the metal into coins. This charge, which varied ac- 
cording to the greed or generosity of the seignior, ranged 
from a bare charge sufficient to cover expenses to as 
much as the people could be forced to pay. Such a 
charge is known as seigniorage. At the present time 
in some countries it is still the custom to charge seignior- 
age. In others the government bears the whole of the 
cost. The latter is the case in the United States. In 
cities where no mint exists, it is customary, however, 
to charge a small percentage of the value of the gold to 
cover the cost of assaying the gold. In England one 
ounce of gold makes coinage to the extent of £3-17-10^. 
The Bank of England, which supplies ail the gold to 
the mint, is allowed to buy gold at £3-17-9. The 
difference of three cents (one and one-half pencej an 
ounce compensates the bank for the loss of interest on 
its expenditure for gold, for a certain time must elapse 
before the gold coin can be turned out from the mint. 

Gresham's Law — In the last chapter some of the 
difficulties in connection with a depreciation of the 

175 



176 AN INTRODUCTION TO ECONOMICS 

coinage were indicated. In order to avoid these dif- 
ficulties it is advisable always to keep the money at 
proper standard value ; that is, the value of the metal 
as a commodity and as coin should be kept equal. Now 
in reforming the coinage some special difficulties al- 
ways arise. One of these is of great importance, for 
it gives us one of the fundamental laws of money. 

If there are two kinds of coinage in existence of 
different commodity value, but of the same nominal 
value, we shall always find that there is a tendency 
for the better class of money, the class which is of 
equal value as commodity and as coin, to go out of 
circulation. The reason for this is not difficult to ap- 
preciate. Suppose a merchant has a supply of what 
we may call " good " money on hand, coined into the 
same denominations as the bad money. He will be 
inclined to charge for his goods on the basis of the 
value of the depreciated coinage. If his good coins 
contain twenty per cent more pure gold than the bad 
ones, he will be inclined to sell the good coins to the 
goldsmiths as bullion, receiving in payment the bad 
coins. He will, of course, receive more money, nom- 
inally, than the coin value of the money he has sold. 
To put it in concrete figures, suppose he has one thou- 
sand dollars, nominally, in good money. This money 
he sells for its gold value to a goldsmith. But prices 
have gone up in terms of the bad money. He sells, as 
far as the goldsmith is concerned, not coins, but gold. 
The gold price, like anything else, stated in terms of 
the depreciated currency, has gone up. Hence the 
merchant receives twelve hundred dollars in the cheaper 
coinage for the gold coins he has sold to the goldsmith. 



SOME MONEY PROBLEMS 177 

As practically every merchant is doing the same 
thing, in a comparatively short time there will be none 
of the good coinage left and all that remains in circula- 
tion will be the cheap money. Sir Thomas Gresham, 
who became Master of the Mint when Queen Elizabeth 
was reforming the debased coinage instituted by her 
venerable father, formulated this argument into what 
is now known as Gresham's Law. Stated briefly this 
law is that " Bad money drives out good." In other 
words, where there are two forms of money in circula- 
tion, the commodity value of one being greater than 
that of the other, there will be a tendency for the coin- 
age of higher commodity value to go out of circulation, 
leaving the cheaper to be used in trade. 

Subsidiary Coinage. Token Money — So far we 
have spoken as if the only coinage in circulation in 
any country consisted of one metal. We know, how- 
ever, that there is more than one metal in circulation 
in the United States. We have gold coins, silver, 
nickel, and bronze. If the statement contained in 
Gresham's Law be true, how is it that the gold has not 
been driven out of circulation by the silver and the 
silver in turn by the nickel ? 

The reason is that we have, in reality, only one 
form of standard money. Consider for a moment the 
difficulties that would arise if all payments had to be 
made in gold. What sort of coin would we have to 
use to pay for a street-car ride ? It would be so small 
as almost to require a microscope to see it. Gold, we 
have already noted, is divisible ; but for very small pur- 
chases, considering the value of gold, gold is not suit- 
able. Hence there must be some substitute. We 



178 AN INTRODUCTION TO ECONOMICS 

substitute silver and nickel for the purpose of making 
small payments. There is no relation between the 
value of the silver coins as silver and their value as 
coins. They obtain their value as coins from an en- 
tirely different source. According to our currency 
laws gold may be used in payments to any extent. If 
we offer coined gold eagles in payment of a debt within 
the country and the creditor refuses to accept them, 
the debt is canceled. But this is not true of the sub- 
sidiary silver and nickel coins. They are only to be 
used for payments of ten dollars or less. The creditor, 
for a sum greater than ten dollars, may refuse payment 
in silver coins. 

How, then, do the subsidiary coins retain their face 
value in the smaller purchases.'^ The United States 
Treasury is ready at any time to redeem silver and 
nickel and bronze coins, provided they are offered in 
amounts not less than twenty dollars' face value, in 
gold. In reality, such subsidiary coins are not true 
money. They are tokens of true money and hence 
are commonly known as token money. Their function 
is to facilitate small payments, and the law definitely 
restricts their use as money to the payment of small 
sums. Of course, there is nothing to prevent any one 
accepting subsidiary coins in payment of any sum if 
he so wishes, but the law does not compel him to ac- 
cept them for sums over a certain amount. 

Bimetallism — This brings us to a subject which 
has caused an immense amount of discussion in almost 
every country. Is it possible or desirable to use at 
one and the same time two different metals as standard 
money ? It is beyond the scope of the present book to 



SOME MONEY PROBLEMS 179 

consider this rather difficult question in detail. But 
it is worth while to point out the probable results of 
such an attempt, particularly as most experience shows 
that these probable results become actual in practice. 

Suppose we use the two metals, silver and gold, and 
coin them into standard money. If, at the time of the 
coinage, an ounce of gold is worth fifteen ounces of 
silver, then the silver dollar must contain fifteen times 
as much metal, by weight, as the gold dollar. Every- 
thing will be satisfactory so long as the fluctuations 
in the value of the two metals, as compared with general 
commodities, follow one another in the same ratio. 
That is, there will be no difficulty if a rise of five per 
cent in the value of gold is accompanied by a rise of 
five per cent in the value of silver. But that is very 
seldom the case. The conditions which affect the 
value of gold have no direct bearing upon those which 
affect the value of silver. Hence before long the ratio 
of exchange of the two metals as commodities will 
change from fifteen to one, to, let us say, sixteen to one. 
In this case gold has evidently become more valuable. 
Gresham's Law will at once begin to operate to drive 
gold out of circulation. If the ratio change in the 
other direction, then silver will become comparatively 
more valuable than gold. Gresham's Law will then 
work to drive silver out of circulation and leave the 
gold. 

Position of Silver Dollars — Now it is true that the 
silver dollars which circulate in this country are stand- 
ard money as far as the law is concerned. They are 
legal tender for any amount. As a matter of fact, 
however, there are so few in circulation, comparatively, 



180 AN INTRODUCTION TO ECONOMICS 

at any rate, that they do not affect the gold coinage. 
The principle of having two metals both standard for 
coinage purposes is known as bimetallism. A full 
discussion of the subject, however, is too difficult for 
an elementary work like the present. 

United States Currency — There are other forms of 
money which must be considered, however, besides 
the metallic coinage. At the present time the currency 
of the United States consists, besides token money, 
of gold and silver, gold and silver certificates, Treas- 
ury Notes, Greenbacks, National Bank Notes, Federal 
Reserve Notes, Federal Reserve Bank Notes, and a 
few other forms which need not be enumerated. All 
this paper money has an important place in the cur- 
rency supply of the country. With the different 
forms of bank notes we shall be concerned later, 
when the banking system has been considered. 
In the meantime it must be noted that these forms 
of paper money all depend for their value on the 
possibility of their redemption in standard money. 
In regard to the greenbacks, for instance, we have a 
definite promise of the government to pay on de- 
mand to any holder of a note the sum stated on that 
note in gold. As long as the government stands ready 
to fulfill its promise there is no difl&culty in keeping the 
greenbacks up to par ; that is, in maintaining the face 
value of the note at the same value as that of gold of 
the same denomination. The same is true of the bank 
notes. Provision is made, as we shall see later, for 
redeeming these notes in gold at the will of the holder. 
These notes are properly termed credit money, as their 
value is based on the credit of the issuing body, whether 



SOME MONEY PROBLEMS 181 

government or bank, or the belief that these bodies 
will fulfill their promises. 

Money and Price — We are now ready to consider 
the relation between money and prices. In an earlier 
chapter it was stated that price is merely another word 
for value in terms of money. Value is the ratio at 
which one commodity exchanges for another. Price 
is the ratio at which a commodity exchanges for money. 
But money is itself a commodity, or represents a com- 
modity. Hence price is merely a suitable term for 
estimating value. 

In our resume of the qualities necessary for a good 
money commodity we found that stability of value 
was one of the most important. Now no commodity 
is absolutely stable. Money is perhaps more stable 
than most other commodities, but it fluctuates con- 
siderably. The value of gold, for instance, will depend 
to a very large extent upon the supply available and 
the demand for it. The demand for gold is not simple, 
however. It is at least twofold. There is the de- 
mand for gold for use in the arts. Jewelers, gold- 
smiths, and dentists require a certain amount of gold 
for their business. Gold is also demanded for the 
purpose of making coins. The more gold taken for 
coinage, the less there is available for the jewelers 
and dentists, and vice versa. Sudden changes in the 
production of gold naturally affect the supply and 
hence the value also. The discovery of gold in Cali- 
fornia, Australia, and Alaska all affected very seri- 
ously the value of gold. What influence has this 
upon prices ? 

In discussing this question it must be remembered 



182 ^ AN INTRODUCTION TO ECONOMICS 

very carefully that money supply is not the only ques- 
tion to be considered in the determination of the price 
of any particular commodity. There must also be 
taken into account the fluctuations in demand and 
supply of the different commodities and all the other 
influences which help to determine their price. In the 
present discussion, therefore, it must be understood 
that the ^phrase " other things being equal " is of the ut- 
most importance. 

Relation of Gold Supply to Prices — The amount of 
wheat which exchanges for five dollars in gold varies 
with the amount of wheat and the amount of gold in 
the market. Assuming that the amount of wheat and 
the demand for it are unchanged, then the effect of an 
increase in the supply of gold will be to increase the 
price of wheat. The increase in the supply of gold 
means a fall in its value. Hence five dollars in gold 
is not worth the amount of wheat for which it formerly 
exchanged. The wheat owner will therefore demand 
more gold for his wheat. In other words the price of 
his wheat will increase. The reverse will be true should 
the supply of gold decrease. 

The fluctuations in the supply of gold are very con- 
siderable and, if we depended entirely upon gold for 
our currency, we should find a much greater fluctua- 
tion in prices than actually is due to currency changes. 
As we have seen, we have supplemented the currency 
from many different sources and as some of these 
sources are elastic, they may be used to counteract 
the effects of fluctuations in the value of gold. 

To follow the effects of the supply of money on price 
we shall first consider the question of actual coin circu- 



SOME MONEY PROBLEMS 183 

lation. Let us suppose that there is a community 
of ten men, each doing business with all the others. 
And let us further suppose that each carries out the 
same number of transactions, and that the supply of 
coins is one gold piece. It is quite possible that this 
one gold piece is sufficient to pay for all the transactions, 
if it moves quickly enough. A pays to B, who passes 
the coin to C, who again hands the coin over, until 
finally it reaches A once more. This means, however, 
that A must wait until the tenth man, J, has received 
the coin before he can be paid himself. Quite possibly 
one of the men may be anxious to gain the coin quickly 
in order to make an additional purchase. If D, for 
instance, wants to receive the money before C gets it, 
he may probably be able to do so, by offering more 
for the coin to B than C is willing to offer. C, there- 
fore, must raise his offer to B in order to anticipate D. 
Hence prices will tend to fall very considerably. Now 
suppose we increase the amount of coinage by adding 
one other coin. If the same number of transactions 
is carried out the coins will not have to pass from hand 
to hand with the same rapidity as formerly. If, when 
there was only one coin, the whole of the transactions 
were completed in half a day, the individual coin 
changed hands ten times in that period. Now, when 
there are two coins, the individual coin only changes 
hands five times in half a day. 

If we suppose that the number of transactions 
doubles, we may consider two alternatives. Either 
the same number of coins is used and the rate of change 
from hand to hand, or the rapidity of circulation, is 
doubled, or else the number of coins is doubled and the 



184 AN INTRODUCTION TO ECONOMICS 

old rate of circulation maintained. In either of these 
cases there will be obviously no change in price due 
to the amount of money. 

If the number of coins and the rate of circulation 
remain unchanged, then as the number of transactions 
increases there will be an increasing intensity of de- 
mand for the coins and hence a fall in prices. If, on 
the other hand, the number of coins increases without 
a corresponding increase in the number of transactions, 
there will either be a decrease in the rapidity of circula- 
tion or an increase in prices. 

The whole of this argument may be expressed in the 
form of an equation. Let P equal price, generally ; 
that is, not the price of any particular article, but an 
average of general prices. Let M represent the amount 
of money in circulation and V the velocity with which 
it circulates. Finally, let T equal the number of trans- 
actions in the same period for which we have esti- 
mated the amount of money in circulation. The 
equation may then be stated as follows : 

p_ MXV 



This equation, however, will not quite accurately 
represent the facts without a little alteration. Money 
functions are performed by instruments which are not, 
strictly speaking, to be regarded as money. Bank 
notes, government notes, token money, checks, and so 
forth, all perform currency functions, and hence they 
must be taken into account. That is, in our concep- 
tion of money for the purposes of this discussion, we 
must consider also the presence of currency other than 



SOME MONEY PROBLEMS 185 

standard money and its velocity of circulation. We 
may, therefore, amend the equation to read like this : 

MV+M'V' 

where M' equals currency other than standard money, 
and V its velocity of circulation. 

From this equation it will readily be seen that any 
increase in the denominator of the fraction, without a 
corresponding increase in the numerator, will mean a 
fall in price, and any increase in the numerator, without 
a corresponding increase in the denominator, will cause 
a rise in price. 

Fluctuations in the Demand for Currency — We have 
already seen that it is of great importance in commerce 
for price to be as little affected by fluctuations in the 
supply and velocity of circulation of currency as possible. 
But there always is a fluctuation in the number of 
commercial transactions. There are definite seasonal 
fluctuations which occur with almost absolute regu- 
larity. These fluctuations are due in a large degree 
to the fact that crops are harvested usually only once 
a year and are sold as soon as possible after the harvest. 
There are other causes with which we need not deal. 
We are concerned merely with the fact that the fluctua- 
tions in the number of transactions exist. ~ 

In order, therefore, to make prices as stable as 
possible, there ought to be provision for a corresponding 
fluctuation in one or more of the factors in the numer- 
ator of our fraction. If we consider these factors for 
a moment, we shall see that such fluctuation, in prac- 
tice, must be limited to the pair of factors introduced 



186 AN INTRODUCTION TO ECONOMICS 

in our second equation. The amount of standard 
money is dependent almost entirely upon the supply 
of gold. Sudden increases and decreases in this supply 
are not to be looked for. The amount of standard 
money in circulation should be regarded as more or 
less constant, or stationary. Moreover, there are 
limitations to the possibilities of increase and decrease 
in velocity of circulation. 

Elastic Currency — Hence such fluctuations as ac- 
tually take place must occur in the supply of sub- 
sidiary currency, i.e., in the supply of bank notes, 
government paper money, checks, and so on. This 
argument will help to emphasize the importance of a 
properly elastic currency and the care which is neces- 
sary in evolving a satisfactory system of bank-note 
issues. 

If we are able so to arrange the amount of currency 
and its velocity of circulation that it increases just in 
proportion as the number of commercial transactions 
increases, and decreases as the transactions decrease, 
we shall have achieved an almost perfect currency sys- 
tem. Unfortunately, in practice it is extremely diffi- 
cult to do so. Increase is easy, but decrease in the 
amount of currency is harder to obtain. The govern- 
ment, for instance, can always issue a supply of paper 
currency base'd upon the credit of the country. Such 
currency is known as fiat money. The difficulty is 
in the retirement of that currency when it is no longer 
needed. The ease with which the issue can be made 
has resulted in constant attempts in one country after 
another to manufacture paper money for the needs 
of government. It was done in this country at the 



SOME MONEY PROBLEMS 187 

time of the Civil War. But perhaps the best illustra- 
tion of the effects can be given from the experience of 
France at the time of the Revolution. 

Effects of Issue of Fiat Money — At that period the 
revolutionary government confiscated the lands of the 
nobility and clergy. On the security of these lands, 
the government issued paper money, known as as- 
signats. The commerce of the country did not demand 
any increase in the currency, and hence the immediate 
effect was a rise in prices. With the rise in prices, the 
money issued by the government bought less goods. But 
the apparent value of the lands, expressed in terms of the 
new money, was increased. Hence the government felt 
justified in issuing more paper, with similar results. 
Finally the money depreciated in value so greatly that 
it was hardly worth the paper on which it was printed. 

A similar effect would be seen at present in this 
country, if the practice of using Liberty Loan Bonds 
as currency were to spread to any great extent. The 
Liberty Loan is based on the credit of the United States. 
It is not based upon the number of commercial trans- 
actions, and the currency needs of the country are 
supplied from totally different sources. So, just to 
the extent that these loans are used as money, they 
will adversely affect prices. Of course, in this case the 
government is not responsible for such use of the bonds. 
The government of this country has already had its 
experience of a paper currency unrelated to the cur- 
rency needs of the country, and has no desire to repeat 
that experience. 

Currency Inflation — When the currency of a country 
is arbitrarily increased by the issue of money which is 



188 AN INTRODUCTION TO ECONOMICS 

not related to the commercial requirements, there is 
said to be money inflation, or inflation of the currency. 
It is almost axiomatic that money inflation is to be 
avoided. The reasons will be obvious to the student 
from the preceding argument. 

Measurement of Prices. Index Numbers — One 
question naturally arises from the foregoing discussion. 
How are we to measure prices so that we can see the 
influence of money upon price .^^ There are so many 
influences upon prices, some affecting one commodity, 
and some another, that it would appear to be almost 
impossible to extricate one particular influence. The 
method adopted is the use of what are known as index 
numbers. There are many methods of constructing 
these index numbers, and in the present work we can 
do no more than indicate the general principle upon 
which they are based. 

What is desired is some method of showing the 
changes in the purchasing power of money. The 
method, stated very simply, is as follows : 

A certain period is taken as a standard The vary- 
ing amounts of a series of different, but important, com- 
modities purchasable for one dollar are listed. Each 
of these amounts is then numbered 100. The amounts 
purchasable for one dollar in the period to be compared 
with the standard period are then listed and again 
numbered according to their percentage of the amount 
purchasable in the standard period. The average of 
the percentage thus obtained will constitute the index 
number for the new" period. That is, it will represent 
the comparative purchasing power of one dollar in 
this period. 



SOME MONEY PROBLEMS 189 

The idea is well illustrated by a table compiled by 
Professor Seager.^ 

January 1, First Year January 1, Second Year 

$1 — 1 bushel wheat — 100 $1 — | bushel wheat — 75 

$1 — I ton coal — 100 $1 — i ton coal — 125 

$1 _ jg. ton iron — 100 $1 — ^ ton iron — 200 

$1 — 20 yards cloth — 100 $1 — 25 yards cloth — 125 

$1 — 10 pounds copper — 100 $1 — 5 pounds copper — _50 

•$5 500 $5 575 

Average $1 — 100 Average $1 — 115 

From this it appears that on the average the pur- 
chasing price of one dollar has increased fifteen per 
cent. By taking a large number of commodities this 
average increase in purchasing power is made more 
accurate. In the compilation of these index numbers, 
it must always be remembered that all commodities are 
not of the same importance. It would not do to take, 
for example, diamonds, orchids, and violins as sample 
commodities. 

The difficulty is met by taking commodities which 
have a very wide sale and then " weighting " them ac- 
cording to their importance. That is, an important 
article, like wheat, for instance, may be enumerated 
three times, while a comparatively unimportant one 
would only appear once. 

^Principles of Economics, p. 376. 



CHAPTER XV 

THE EVOLUTION OF THE BANKING SYSTEM 

One of the most important elements of human 
character upon the existence of which the modern 
economic structure rests is general honesty. If we 
did not implicitly believe that in the main every in- 
dividual is fundamentally honest, there would be no 
possibility for the vast commercial transactions which 
continually take place to-day. 

Honesty the Basis of Economic Structure — Credit 
is the basis of business, and at bottom, credit is nothing 
more than a belief that an individual will carry out 
his part of a contract. In the strict interpretation of 
the word credit, as applied to business operations, we 
may state that a credit transaction involves a promise 
to pay money at some future date. That is, there is 
a contract one part of which is to be fulfilled at a future 
date. Now, unless contracts such as these were 
habitually fulfilled at the appointed time, there would 
be no possibility of conducting business. Neverthe- 
less, although it is true that there is a general belief 
in human honesty, that is no reason why precautions 
should not be taken to prevent evil resulting through 
occasional failures to live up to the general reputation. 
Credit must be organized. In the organization of credit 
the banks play the most important part. In fact the 
main function of the banking business is to organize credit. 

190 



THE EVOLUTION OF THE BANKING SYSTEM 191 

We can conceive of the business of transportation 
being carried on as it is in some parts of Spain, for 
instance, by the use of springless carts with soKd 
wooden wheels, creaking and jolting along the bad 
road. But we know that if we, in this country, had 
to depend upon such vehicles the greater part of our 
commerce must cease. Our wheels must be lubricated ; 
our vehicles must be more efficiently designed ; the 
physical force of the human body must give place to 
the forces of nature organized and subdued to human 
will. There is a vast difference between the creaking 
wooden wheels of the primitive oxcart and the ball- 
bearings of the modern automobile. 

Banks the Lubricants of Commerce — Just as we 
have progressed infinitely from the primitive means 
of transport to the modern, so have we also progressed 
from primitiA^e conditions of barter-exchange to the 
modern system of a complicated money and credit 
organization. The banks may be regarded as the 
lubricants of trade. Trade, indeed, could exist with- 
out banks. But it would creak and jolt like the un- 
greased wheels of an oxcart. The banks smooth the 
progress of trade; they make possible transactions 
of vast amounts between people widely separated. 
The average individual seldom realizes to what extent 
the comforts and graces of his own life are dependent 
upon the existence of a good banking system. 

Essentially, the principles of banking are not new. 
Credit instruments, inscribed upon burnt bricks, have 
been discovered in the ruins of ancient Assyria. But 
our modern banks, no matter what similarities they 
may show to ancient prototypes, have not been de- 



192 AN INTRODUCTION TO ECONOMICS 

veloped from them. There is a more definite develop- 
ment to be observed from the period of the discovery 
of the New World. Without going into history too 
deeply, we may summarize the development of the 
banking institutions while gaining some idea of the 
functions which the banks exercise. 

Beginning of the Deposit System — Consider, for a 
moment, the position of a medieval merchant who 
desired a safe place to keep his mcJney, which was en- 
tirely composed of coin or bullion. He seldom had a 
proper place to keep the money, and yet thieves were 
even more common then than now, in spite of the greater 
severity of the laws. One kind of merchant was com- 
pelled by the nature of his business to have a strong 
place in which to keep his merchandise. That was 
the goldsmith. The materials of his business were at 
the same time the materials of which money was made. 
What could be more natural, therefore, than the sug- 
gestion that the goldsmith be asked to care for the 
surplus money of the other merchants.'* For a small 
percentage of the sum cared for, the goldsmith was 
willing to keep the money in his own vaults, safe, as 
far as anything could be safe in those days, from the 
attacks of thieves. The merchant could draw out 
his money as he pleased, and it was worth while for 
him to pay a little to the goldsmith for guarding the 
money. 

But the goldsmith, being the merchant who had the 
greatest store of money material, was also the individual 
to whom borrowers naturally applied for loans. From 
these two facts we can develop the beginning of a 
banking system. The merchants who left their money 



THE EVOLUTION OF THE BANKING SYSTEM 193 

with the goldsmith for safekeeping were the original 
depositors. Those who borrowed from the goldsmith 
correspond to om' present-day bank clients. 

It would occur, sooner or later, to the goldsmith, 
that he was seldom called upon to return, at any one 
time, the whole of the sums deposited with him. There 
would appear to be no reason why he should not use 
some of these deposited funds to lend to his clients, 
thus reaping interest from both depositors and bor- 
rowers. But this could not be kept secret indefinite'ly. 
Competition among the goldsmiths for deposits which 
they could lend out would soon convince the depositors 
that their money was not always intact in the gold- 
smith's vaults. Competition would also lead to the 
solicitation of deposits backed by offers to receive such 
deposits and care for them without charge, and even, 
later on, to pay a small rate of interest to the depositor. 
We have here two of the chief functions of a bank — 
the deposit of money and the lending of money. It is 
but a little step to the third of these functions, the 
issue of bank notes. 

Bank Notes. Origin — Money was subject to con- 
siderable difficulty in transport. It was liable to theft 
very easily. An order on a banker, however, or on a 
goldsmith could be carried easily, and if stolen, need 
involve no loss, for the order could be made payable 
only to a certain definite individual. Such orders, 
checks we call them now, soon became. fairly common. 
Indeed, they were not unknown in ancient Rome. A 
merchant who wished to make a payment to another 
at a distance could obtain from a goldsmith an order 
upon another goldsmith residing at the place where 



194 AN INTRODUCTION TO ECONOMICS 

payment was to be made. He could then forward that 
order to his creditor, who obtained the money from the \ 
goldsmith upon whom the order was drawn. Similarly 
this second goldsmith could issue orders upon the first. 
The cross transactions would tend to cancel one an- 
other and any balances could be carried out by the 
actual transfer of gold. This would only have to be 
done occasionally, however, and the goldsmiths would 
be in the habit of taking extraordinary precautions in. 
su6h shipments. | 

An order upon a goldsmith of recognized standing 
would soon tend to be regarded as equivalent to cash 
and consequently would be passed from hand to hand 
as such. The orders, therefore, might be outstanding 
for a considerable time before they were presented; 
for final payment. The goldsmith, in the meantime, 
would be able to lend out the funds against which the 
orders were drawn and so obtain additional profit from \ 
the interest gained from the loan. Hence he would 
be anxious to have as many of these orders outstand- 
ing as possible. The natural result was that he issued 
his own orders drawn upon his own funds. These were 
rather promises to pay than orders. They consisted 
of a promise to pay the bearer on demand the sum 
named in the note. This is all that a bank note is at 
present. 

The Deposit System — Essentially we have now all 
the elements of a bank. But a bank is somewhat more 
complicated than this and we shall now attempt an 
analysis of the functions indicated above. First, let 
us consider the deposit system. Let us imagine that 
there exists a community of ten merchants, who keep 



I 



THE EVOLUTION OF THE BANKING SYSTEM 195 

their funds deposited in one bank. Let us suppose 
further that each one has on deposit the sum of $1000. 
These merchants trade with each other and conse- 
quently at times one has to pay the other for goods 
or to receive money for sales made. A, let us say, 
buys $100 worth of goods from B. He makes pay- 
ment to B by giving him an order on the bank, some- 
what as follows : 

To the Bank of X, Blankville. October 10, 1918 

Pay to the order of B the sum of one hundred dollars. ($100) 

(signed) A. 

B presents that order to the bank and may do one 
of two things. He may request the payment of the 
$100 in cash, or he may ask that the amount be added 
to his own account. Probably he does the latter. If 
so, all that occurs is a bookkeeping transaction in the 
bank. A's account is reduced to $900 and B's is in- 
creased to $1100. No cash has been required. B, 
however, is also trading with C and with D and so he 
must make his payments. He does so by drawing his 
check in the same manner as A. Seeing that all the 
accounts are contained in one institution, there should 
be no need of cash at all, for all that is necessary is 
the transfer of amounts from one account to the other. 

Necessity for Bank Deposit Reserves — This is 
simple enough when there is only one institution. But 
that is seldom the case. Before we consider the situa- 
tion when there are two or more banks, let us discuss 
the position of the bank itself. It is quite possible 
that each of its depositors has some relations outside 
the other nine merchants, for which a certain amount 



196 AN INTRODUCTION TO ECONOMICS 

of cash will be required. The merchants themselves, 
for instance, will require some funds for small pur- 
chases, like traveling expenses, for which checks are 
seldom used. They will, therefore, call upon the bank 
to pay back a certain amount of their deposits when they 
require such funds. The bank must be prepared to 
meet these demands, and therefore it will be compelled 
to have a certain amount of actual money ready to 
hand over the counter. Again it is possible that one 
of the merchants may give up business and leave the 
town, in which case he will withdra\#all his funds. 
The bank must be ready to pay back at any time. But 
it may safely reckon on the fact that the amount of 
withdrawals in any one day will represent only a small 
fraction of the total amount deposited. If, therefore, 
the bank maintains sufficient funds on hand to meet 
what demands arise, it may use the remainder for the 
purpose of making loans. The amount of reserve, 
as these cash funds are called, will vary according to 
conditions of trade, but there will always be a surplus 
available for loans. The bank, then, protects its de- 
positors' immediate needs by a reserve of cash and 
makes its profits by extending loans to its customers. 
The more nearly its depositors comprise all the mer- 
chants of the community, the smaller will the reserve 
fund need to be. 

The Case of Two or More Banks. — Now we may 
return to the case of two or more institutions. Sup- 
pose there are two banks, each with five depositors, 
A, B, C, D, E, and F, G, H, I, and J respectively. 
Now if A pays a check to B, B will deposit it in 
A's own bank, and so the transaction will be similar 



i 



THE EVOLUTION OF THE BANKING SYSTEM 197 

to that already described, i.e., a bookkeeping opera- 
tion within the bank. But suppose A, instead of 
drawing his check in favor of B, makes it out to F. 
In this case F wih deposit the check in his own bank. 
That bank must then collect the money from the other. 
It is possible that to do so a messenger will be sent 
from the second bank to the first, carrying the check 
with him and receiving cash from the teller at the first 
bank. 

But A's check is not the only one that will be drawn 
in the course of the day. H may draw a check in favor 
of C, who will deposit it in bank number one. This 
bank will, possibly, also send a messenger, carrying the 
check for payment to the second bank. It is con- 
ceivable, therefore, that the two messengers may pass 
each other in the street carrying money from the two 
banks. 

This is obviously a waste of currency. It would 
be better for each of the banks to wait until the end 
of the day and then find out how much money each 
owes the other, settling the balance in cash. This 
would be perfectly simple in the case of two institutions, 
but in any large city there are many more banks than 
two, and the difficulty of balancing up each day is, 
consequently, much greater. Still the essential prin- 
ciple is the same, though the mechanism is a little 
more complicated. 

The Clearing House — Let us suppose that, in a 
certain city, there are ten banks. These banks will 
form a " clearing house association " for the purpose 
of balancing their indebtedness each day. Each bank 
will be numbered. At the close of the day the checks 



198 AN INTRODUCTION TO ECONOMICS 

received in each of the banks will be arranged into 
groups. The first group will consist of checks drawn 
upon the bank in which they were deposited. These 
will be cared for by bookkeeping transfers in the bank 
itself. The remaining nine will each consist of checks 
drawn upon one bank. The first will have all checks 
drawn upon bank number two, the next all checks drawn 
on bank number three, and so on. These checks will 
be wrapped up in separate bundles after the total 
amount represented on their face has been checked. 

At a certain definite time next morning two messen- 
gers will be sent to the clearing house, carrying with 
them the bundles of checks. They carry also a state- 
ment showing the amount drawn upon each of the 
other banks and the total amount due from all. The 
clearing house will be illustrated better by reference to 
the diagram (Fig. 6). At a central table sits the clerk 
of the clearing house. Around this table are grouped 
in a circle ten desks, each assigned to a particular 
bank. On arrival at the clearing house, one of the 
messengers hands to the clerk of the clearing house a 
copy of the statement of the amounts due to his bank. 
The other messenger takes his place at the desk al- 
lotted to his bank. The first messenger carries the 
nine bundles of checks, each bearing a slip stating the 
amount due upon the checks in the bundle. He also 
takes his position at the desk belonging to his bank. 
Before the signal to commence operations, each desk 
will be attended, therefore, by two messengers. At a 
given signal, usually the striking of a bell, the messenger 
from bank number one will start for the desk of bank 
number two. There he will deposit the bundle of 



THE EVOLUTION OF THE BANKING SYSTEM 199 

checks drawn upon that bank, receiving a receipt for 
the amount stated on the shp. He will then pass on 



F\G.Q-Diaqram io lUastrafe Ctearin^ House Method. 




C. H.C.. - CLEARING HOUSE CLERK. 
R - RECEIVING MESSENGER, 

D - OELlVERIHG MESSENGER. 



to the desk of bank number three and repeat the per- 
formance. Meanwhile the messenger from the tenth 



200 AN INTRODUCTION TO ECONOMICS 

bank will have handed a bundle to the messenger at 
the desk of the first, then proceeding to the second 
desk. So the messengers will circulate until each has 
passed in his nine bundles and returned to his own bank, 
bearing nine initialed slips which constitute receipts 
for the bundles of checks handed over. 

Debtor and Creditor Banks — The receiving mes- 
sengers have occupied themselves in totaling the 
amounts stated on the bundles handed to them. They 
know, of course, how much is due to their own banks, 
from the statement brought with them. When they 
have completed the new total they are able to draw 
a balance between the two. If they find that the 
amount due from the other banks, as represented in 
their first statement, is greater than the amount due 
from their own bank, as shown in the total which they 
have just calculated, the balance is in favor of their 
own bank, which is known, for the day, as a creditor 
bank. If, on the other hand, the statement which was 
made up by their own bookkeepers is less than the 
total of the bundles of checks drawn upon their bank, 
then their bank is a debtor. 

Obviously all banks cannot be debtor, or all creditor. 
The amount of the debits must equal that of the credits. 
If the amounts do not agree, some one has made a 
mistake, whereupon each clerk makes a recast of his 
totals to find the error. Meanwhile, the clerk of 
the clearing house has also made his comparison 
from the statements handed to him before the open- 
ing of the clearing. From these statements he pre- 
pares a summary of all the transactions, and has, at 
the end, a statement which should agree with the 



THE EVOLUTION OF THE BANKING SYSTEM 201 

combined calculations of the messengers from the 
member banks. 

The balances are paid either in cash, or, sometimes, 
by checks. Thus the use of money is economized to 
an enormous extent. Without the clearing house, the 
use of checks in payment of commercial transactions 
would be very greatly curtailed. 

The Bank Loan — So far, we have dealt only with 
the deposit system, but we have not considered an 
extremely important, indeed, an essential function 
of the bank — the lending of money. A bank's profits 
depend upon the quantity of successful loans made. 
They consist almost entirely of the interest charged 
for these loans. A loan may be made in three forms. 
The borrower may receive government currency over 
the counter, or he may receive bank notes of the lend- 
ing bank. The greatest amount of loans, however, is 
made in the form of a deposit. Let us see why this 
is. Suppose a borrower obtains a loan from the bank 
amounting to $10,000. It is conceivable that the bank 
may pay him in gold. But the borrower seldom re- 
quires the whole amount of the loan immediately. 
He wants to be able to have sums from time to time as 
required. He will naturally, therefore, want a safe 
place to keep the money until the time comes to spend 
it. What safer place can he have than the bank.? 
Consequently, having received the coin, he deposits 
it to his credit, and draws checks against the deposit. 

The gold, therefore, will be paid out by the paying 
teller and carried to the receiving teller's v/indow and 
there deposited. This means that the gold will have 
passed out at one window and in at another. There 



202 AN INTRODUCTION TO ECONOMICS 

is no reason why the transaction could not be done by 
entering the amount of the loan directly into the pass- 
book of the depositor, who is also the borrower. This, 
in fact, is what actually happens. When the borrower 
negotiates the loan with the bank, instead of receiving 
currency in any form, he has the amount of the loan 
credited to him and he then uses the account to draw 
checks with which to make his payments. 

Accoimnodation Loans — We may divide the pur- 
poses for which loans are made by banks into three 
classes. First, there are those loans which are purely 
for the purpose of accommodating the borrower. The 
reason why the borrower wants. the money is not ap- 
parent. He may wish to take a trip to Europe, or to 
buy an automobile, or to redecorate his house, or any 
of a multitude of different methods of spending. Loans 
of this type are known as accommodation loans, and 
the notes signed as evidence of the obligation are 
called accommodation paper. This type of loan was 
extremely common in earlier history. A good example 
is that contained in The Merchant of Venice. Bassanio, 
in borrowing money from Antonio, merely desired to 
make a brave show when he went to court Portia. 

Capital Loans — The second type is that secured by 
borrowers who wish to add to their working capital. 
If a firm, for instance, has spent all its present capital 
in the purchase of buildings and machinery, and re- 
quires additional funds to provide for the working 
expenses of the business before the returns begin to 
come in, it frequently negotiates a loan with a bank. 
The first type of loan is usually made not on the credit 
of the borrower, but on the value of security deposited 



THE EVOLUTION OF THE BANKING SYSTEM 203 

with the bank. A pawnbroker's loans are of this 
type. The second may be made either on security 
offered, or on the credit of the borrower. If the bank 
beheves that the borrower has sufficient capital already 
invested in his business to make it pay, and that he is 
a capable and honest business man, the loan may be 
made without any security other than this belief. 

Commercial Loan — The third type of loan is ob- 
tained for the purpose of facilitating commercial opera- 
tions, the purchase and sale of goods. Let us suppose 
that a merchant has sold a thousand dollars' worth of 
dry goods. He gives, let us say, thirty days* credit. 
That means that for thirty days he must wait before 
receiving payment. Most likely he will find that some 
time during that thirty days he could make good use 
of the money. If he cannot obtain it, profits, other- 
wise possible, will be lost. He therefore goes to the 
bank and obtains a loan on the strength of the money 
due to him at the end of thirty days. Frequently, and 
much more so of late years, the debtor will sign some 
form of obligation, agreeing to make the payment at 
the maturity of the credit period. This obligation 
will be indorsed by the creditor and handed to the 
bank. The latter then becomes the legal owner of 
the sum mentioned at the maturity, and the retail dry 
goods merchant will pay the sum stated on the note to 
the banker when it is presented. 

Discount — The merchant to whom the money was 
originally due will receii^e :rom the bank a sum slightly 
less than the amount called for in the note, the differ- 
ence being the banker's profit on the transaction. 
Such a loan is usually referred to as a discount. The 



204 AN INTRODUCTION TO ECONOMICS 

bank " discounts " the note indorsed by the merchant 
to whom the money is due. This particular type of 
loan is called a commercial loan from the nature of the 
transaction on which it is based. Its importance 
in the operations of commerce can hardjy be exagger- 
ated. Few retailers can afford to carry a stock suf- 
ficient for the needs of their customers, unless they are 
allowed a certain time to sell the goods before being 
called upon to pay the wholesale dealer from whom the 
goods were bought. If there were no possibility of 
discounting the evidences of indebtedness on the part 
of the retail dealers, the wholesale merchant would 
often be unable to give reasonable credit terms without 
curtailing the amount of business done. If there were 
no means of discounting, the loss would fall heavily 
upon the consumer, for higher prices would undoubtedly 
be the result. The merchants, having to wait for their 
money, would be compelled to ask higher prices from 
their customers, and these higher prices would in- 
evitably be passed on to the consuming public. 

Value of Discount System — The fact that the banks 
stand ready to discount commercial paper, therefore, 
allows the retailer a reasonable credit period, and at 
the same time permits the wholesales dealer and manu- 
facturer to turn over their capital much of tener, thereby 
making possible greater production and a consequent 
increase in the total satisfaction gained by the com- 
munity. It further provides for the full utilization 
of idle capital, for the increased production calls for 
greater working capital, and that greater capital is 
drawn from otherwise idle funds in the hands of 
bankers. 



THE EVOLUTION OF THE BANKING SYSTEM 205 

Bank Notes — The third of the banking functions 
is the issue of bank notes. A bank note is nothing 
more nor less than a promise on the part of a bank to 
pay a certain sum on demand in lawful currency. 
There is a technical similarity between an ordinary 
demand promissory note and a bank note. But the 
difference consists partly in the fact that the signa- 
ture of the bank officials on the note is taken without 
question, whereas the signature of a private promissory 
note usually must bear investigation before it can be 
generally accepted, and partly in the fact the govern- 
ment regulates the issue of bank notes so as to protect 
holders, whereas the holders of ordinary promissory 
notes have only recourse to the provisions of the law 
governing negotiable instruments. The bank has an 
identity which differs from that of a private individual, 
in that it is regarded almost without question as a safe 
institution. In order that the reputation may be 
deserved, in every civihzed country the methods of 
banking are subject to regulation by government. In 
our next chapter we shall consider the method of regu- 
lation adopted by the United States. 



CHAPTER XVI 

THE AMERICAN BANKING SYSTEM 
I. The National Banks 

It is impossible in a brief outline to give anything 
like an adequate account of the banking systems in 
vogue in the United States. Hardly any system tried 
in any country has been without its example in Ameri- 
can procedure. At best all that can be done here is 
to outline the essentials of the present system and 
leave the detailed study to texts on banking. We 
shall, therefore, neglect the consideration of the varie- 
ties of State institutions, merely remarking that with 
the exception of the note-issuing power they are not 
very dissimilar from the National banks, and confine 
our attention to the two outstanding institutions, the 
National banks and the Federal Reserve banks. 

Early History — The early history of banking in 
the United States provided illustrations of the best and 
the worst forms of banks. Generally speaking, how- 
ever, up to the time of the Civil War the banking 
conditions of the country, from whatever point they 
could be regarded, were unsatisfactory. The issuing 
of bank notes was uncontrolled and the notes varied 
in value according to the standing of the institution 
which issued them. The reserves maintained against 
deposits were in many cases totally inadequate. The 

206 



THE AMERICAN BANKING SYSTEM 207 

risks taken by the bankers in making loans were too 
highly flavored with speculation to be considered in 
any way sound banking. 

The currency dijBBculties of the country at the time 
of the outbreak of war were not entirely due to the 
banking system, but they were intimately connected 
with it. Three problems, in this connection, faced 
the government. First, the country must be provided 
with a sound currency system. Second, the safety of 
the funds belonging to depositors must be guaranteed 
in a much more satisfactory manner than formerly. 
The third problem was not necessarily connected with 
the banking system but it influenced the design of the 
new system very materially. Funds were necessary 
for war purposes and, as these funds were to be ob- 
tained by the sale of government bonds, a market for 
these bonds had to be found. The government tried 
to solve all these problems by forming the National 
banking system. 

National Banking Act — The Act which formed 
this system is known as the National Banking Act, 
and was passed in 1863. Since that time it has been 
frequently amended, but we shall not deal with the 
amendments separately. In principle, the Act may 
be briefly described as follows : 

Minimum of Capital — The government issued charters 
to banking institutions which complied with the stipulations 
laid down in the Act. These institutions were compelled 
to possess a certain minimum of capital, which varied accord- 
ing to the number of the population served by the bank, but 
was not allowed to fall below $25,000 in any place. In 
addition to the capital, each bank had to lay by a certain 



208 AN INTRODUCTION TO ECONOMICS 

portion of its profits each year to form a "surplus," until 
the surplus amounted to twenty per cent of the paid-up 
capital. 

Bo7id Purchases and Note Issues — The smaller banks were 
to buy government bonds to the extent of one quarter of 
their paid-up capital, the larger banks buying a minimum 
of $50,000 worth. By this it was hoped that the de- 
sired market for government bonds would be provided. Of 
course, it was not to be expected that the banks should be 
deprived of the use of so much of their capital, and so each 
bank was allowed to issue bank notes to the extent of, at 
first, ninety per cent, and later, one hundred per cent of the 
face value of the bonds. The bonds were held by the Treas- 
ury as security for the bank notes issued. In this way the 
security of the bank notes rested upon the credit of the 
federal government. Thus two of the problems were sup- 
posed to be solved. 

Reserves — In regard to the third problem, the safeguard- 
ing of depositors, the Act laid down rules for the main- 
tenance of minimum reserves, and directed the manner in 
which these reserves were to be kept. First, the banks of 
the country were divided into three classes. Those situated 
in New York, Chicago, and St. Louis were called Central 
Reserve City hanhs. Forty-nine other cities were named as 
Reserve cities. All National banks situated outside of 
these fifty cities were termed Country hanks. The reserves 
required under the act varied according to the status of the 
bank. Central Reserve City banks were required to main- 
tain minimum deposit reserves of twenty-five per cent of 
the total deposits, these reserves to be in cash carried in 
the vaults of the individual banks. The Reserve City 
banks were also required to maintain reserves of twenty-five 
per cent, but with this difference ; in their case only twelve 
and a half per cent of the deposits need be kept in cash 



THE AMERICAN BANKING SYSTEM 209 

carried in the vaults of the bank. The other half of the 
reserves might be left on demand deposit with a National 
bank in a Central Reserve city. 

In the Country banks, a reserve of fifteen per cent had to 
be kept, six per cent being cash in vaults, and the remainder 
on deposit in Central Reserve or Reserve cities. 

Bank Examinations — The business community was 
protected against unwise banking by prohibitions of 
certain forms of loans which were of too speculative a 
nature, and by a system of periodical examinations 
conducted by federal examiners. The Secretary of 
the Treasury might also call for reports as often as 
five times each year. 

Criticism of the System — The system thus out- 
lined was undoubtedly a very great improvement over 
that which had preceded it, but it did not really solve 
the problems which led to its adoption. In the first 
place, the market for government bonds was not very 
widely increased. There was no prohibition on the 
issue of bank notes by other institutions than National 
banks. It was assumed that the State banks, that is, 
the banks which operated under charters given by the 
States, as distinguished from federal charters, would 
flock to join the new system. Most of them, however, 
preferred to retain the more elastic procedure allowed 
under the State laws. To remedy this defect, an act 
was passed in 1865 which imposed a tax of ten per cent 
upon bank note issues other than those of National 
banks. This was not, in form, a direct prohibition, 
but in practice it amounted to such. The number of 
National banks immediately increased very greatly. 



210 AN INTRODUCTION TO ECONOMICS 

The provision of a market for bonds, however, was 
a minor and temporary consideration. The two im- 
portant purposes of the act were to remedy the cur- 
rency and to safeguard the depositors. Let us see 
how the provisions of the act succeeded in these respects. 

National Bank Notes — A bank note is, as we have 
said in a previous chapter, merely a promise on the 
part of a bank to pay to bearer, on demand, the sum 
mentioned on the face of the note. If the bearer can 
always rely upon the fulfillment of the promise, the 
note issue is kept up to a par with the rest of the money 
of the country. The note must, therefore, be ade- 
quately secured. But there are two points of view to 
be considered in determining the security of the note 
— the ultimate and the immediate security. In re- 
gard to the ultimate security, provision must be made 
for the repayment of the face value of the note when 
the note is finally retired. In the case of the National 
bank note, that security is found in the deposit of 
government bonds with the Treasury of the United 
States. If a bank should fail, the bonds will be sold 
to pay the holders of the notes issued by the bankrupt 
institution. In case the bonds do not realize their 
own face value, the balance due to the note holders 
constitutes a first charge upon the assets of the bank. 
It would appear, therefore, that the note holders are 
adequately secured as far as the ultimate redemption 
of the notes is concerned. 

Redemption of Notes — But there is a second point 
of view which is of almost greater importance. It is 
not sufficient that the ultimate security of the notes 
be protected. Their immediate redemption on de- 



THE AMERICAN BANKING SYSTEM 211 

mand is a primary necessity. To satisfy this require- 
ment, the Act provided that in addition to the bonds 
deposited with the Treasury, each bank must main- 
tain a fund, in gold, amounting to five per cent of the 
notes issued, with the Secretary of the Treasury. 
From this fund notes were to be redeemed. Further, 
all National banks were compelled to accept National 
bank notes, no matter where issued, at face value as 
deposits. 

Suppose the National City Bank of New York re- 
ceives on deposit, $5000 of notes issued by the First 
National Bank of San Francisco. The National City 
Bank will forward these notes to the Treasury and 
$5000 will be transferred from the redemption fund 
belonging to the First National of San Francisco to 
that belonging to the National City Bank. The San 
Francisco bank will then be informed by the Treasury 
that $5000 of its notes have been redeemed, and it will 
be instructed to replenish the fund to that extent. 
When this has been done, the notes are forwarded to 
San Francisco to be reissued. The Treasury, there- 
fore, acts as a sort of clearing house for the note issues 
of the country. 

National Notes as Currency — From the point of view 
of security, both ultimate and immediate, therefore, the 
National bank notes must be considered as perfectly 
satisfactory. But there is a further difficulty which 
was not so successfully met. In the previous chapter 
it was pointed out that the bank notes of a country 
formed the principal part of the elastic money ma- 
terial. If this elastic currency is to be satisfactory for 
the commercial needs of the country, it should expand 



212 AN INTRODUCTION TO ECONOMICS 

when the needs of commerce demand more currency ; 
that is, when the commercial transactions become 
heavier and more numerous, and when conditions 
change, they should contract. It is doubtful if any 
currency system ever invented has perfectly satisfied 
this need. But the National bank notes certainly did 
not do so. This was due to the nature of their security. 

To understand this, we must examine the nature of 
profits obtained by issuing bank notes, on the security 
of government bonds. First, there is the interest paid 
by the government on the bonds purchased by the 
banks. This was six per cent at first, but the bulk of 
the existing National bank notes is secured by two 
per cent bonds. Secondly, the notes are lent by the 
banks to borrowers, and the interest charged on the 
loans constitutes a part of the profits. Against these 
profits the expenses of the issue must be counted. 
These include the cost of issuing the notes, the federal 
tax on the issue (amounting to one half of one per 
cent on the notes secured by two per cent bonds), and 
some other expenses with which we need not deal. 
Subtracting these expenses from the gross profits, we 
obtain the net profits on the issue. 

Perverse Elasticity — According to a calculation 
made recently the net profits made by a bank note 
issue, over and above the interest received on loans 
made (which would be received if cash had been lent 
instead of notes) amounted to about 1.2 per cent. 
This is a small amount, but it becomes important 
when business is slack. Hence, in times of depression 
when it is important that the banks, like every other 
business, must make every effort to secure profits, note 



THE AMERICAN BANKING SYSTEM 213 

issues are increased in order to gain this extra interest. 
This means, therefore, an increased issue of notes. 
But the very fact that conditions are depressed is 
evidence itself of a smaller need for currency. So, in- 
stead of the currency being reduced as it should be, it 
is increased. 

Again, when times are good and business is brisk, 
securities appreciate in value, and it may be profitable 
for the banks to sell their bonds to obtain the profit 
due to a sale at a higher price than was paid for the 
bonds. But the bonds cannot be sold without retiring 
the currency issued upon that security. Hence, the 
tendency is to sell the bonds and retire currency just 
at the period when business conditions suggest the 
advisability of increasing the currency. We may say, 
then, that National bank notes are not inelastic but 
perversely elastic, expanding when they should con- 
tract, and contracting when they should expand. 

In spite of this very grave defect, however, the 
National bank notes have proved to be infinitely better 
than the wild issues which preceded them. We no 
longer find merchants making mathematical computa- 
tions of the value of the notes received in payment for 
goods, on the basis of published schedules of varying cash 
values. The currency is sound, but not satisfactory. 

The Reserve System — We must now turn to the 
reserve system under the National Banking Act. Of 
this we may say the same that has been already said 
in regard to the National bank notes — ■ it is a great 
improvement over the older system, or lack of system, 
but it has, nevertheless, grave disadvantages. The 
question first arises as to the advisability of legal 



214 AN INTRODUCTION TO ECONOMICS . 

control of the amount of reserves. It has often been 
argued that the bankers themselves are the best judges 
of the amount of reserves necessary for the adequate 
protection of the depositors. There is a very large 
amount of truth in this contention, but the answer to 
the argument is a complete justification of the system. 
The only way in which one can test the truth of the 
statement of the banker's abihty to judge of reserves is | 
by experience. In some countries (as in England, for 
example), experience has shown that if the decision as 
to the amount of reserves against deposits is left to the 
bankers, the margin of safety will seldom be over- 
stepped. But American business men claim that 
English bankers are unprogressive and that they are 
too unwilling to take a chance. The last criticism 
cannot be urged against American bankers. On the 
contrary it may be said that the early bankers in the 
United States were too willing to take chances. 

This is not to be wondered at. They lived in a new 
land, whose constantly unfolding promises of immense 
riches provided a continual incentive to new enter- 
prises. It could hardly ever be foreseen whether a 
new enterprise would be a huge success or an equally 
colossal failure. Optimism abounded and the bankers 
shared in the general beHef in almost impossible prog- 
ress. The result was a strong tendency to extend credit 
beyond sound limits and thus leave depositors in- 
adequately secured. As a first step towards rendering 
the banking system sound, therefore, the government 
had to take the decision as to the amount of reserve to 
be kept out of the hands of the bankers, and lay down 
a minimum below which they must not fall. 



THE AMERICAN BANKING SYSTEM 215 

Defects of the System — Having decided upon the 
minimum, the next step in the process of estabhshing 
the system was to direct the manner in which the re- 
serves should be kept. It is against this method 
adopted under the National Banking Act that most 
of the criticisms have been aimed. Broadly speaking, 
the reserves may be divided into two classes. There 
are first, the cash reserves held in the vaults of the 
individual banks. Secondly, there are the reserves 
deposited in the reserve cities and central reserve 
cities. , To .consider first the cash reserves we may 
use the simile suggested by one of the most important 
framers of the Federal Reserve Act. Suppose the fire 
protection system in a big department store were to con- 
sist of fire buckets, one or two buckets being placed in 
each room. And suppose, further, that in case of a 
fire starting in one room of the building, the only water 
supply available should be the two buckets in that 
room, the other buckets being used only when the fire 
had spread to the room in which they were situated. 
In such a case every one would admit that the fire 
protection was ridiculously inadequate, even if the 
total water in all the buckets were ample to extinguish a 
large fire. Yet this is what happens under the cash 
reserve system in the individual banks. Each bank 
in time of crisis hangs on to its little hoard of cash for 
the protection of its own creditors. In every crisis 
this protection has been inadequate, although the total 
cash resources of all the banks, properly applied, would 
have met all the needs. 

But, it may be said, how does the deposited reserve 
affect the situation? This brings us to another con- 



216 AN INTRODUCTION TO ECONOMICS 

sideration. In the first case we are not sure that the 
deposited reserves actually exist. Suppose a country- 
bank has $50,000 of deposited reserves in a New York 
National bank. It is constantly drawing upon that 
reserve by selling drafts on New York. That is, the 
merchants in the town in which that country bank is 
situated in making payments to New York buy drafts 
from the bank. These drafts are nothing more nor 
less than checks drawn by that bank upon its deposit 
account with the New York institution. As fast as it 
draws those checks, and thus diminishes the deposit 
credit, it must build up the deposits to maintain the 
reserve amount. The deposits are renewed by paying 
into the New York bank checks which have been drawn 
upon some New York institution and paid into the 
country bank in question. These checks represent 
amounts paid by New York purchasers of goods sold 
by merchants living in the neighborhood of the country 
bank. Now it has been the habit of the country banks 
to consider the deposits as made as soon as the checks 
have been put in the mail box. The New York bank, 
however, would not credit the deposit account until it 
had received the checks, and it is possible that an 
interval of several days might elapse before the checks 
actually arrived. We have, therefore, two different 
statements as to the amount of reserve for this par- 
ticular country bank. Let us assume that the $50,000 
has been reduced by half. The balance is placed in 
the mail box and, according to the accounts kept in 
the country bank, the deposited reserve is now back 
again at $50,000. But the figures for that same re- 
serve, if taken from the New York bank, would show 



THE AMERICAN BANKING SYSTEM 217 

only a reserve of $25,000 during the interval necessary 
for the transmission of the new deposits. 

It is, therefore, doubtful if the deposited reserves 
are anything approaching the amount shown on the 
books of the depositing banks. If, however, we admit 
the existence of the deposits, we must also consider the 
fact of their availability. It is essential that these 
deposited reserves be withdrawable on demand. Con- 
sequently the banks which hold the reserves must so 
lend out the money that they can call the loans at any 
time. If they lend the money out on even ordinary 
commercial terms of fifteen, thirty, or sixty days, it is 
quite conceivable that they could not control the funds 
in case of a sudden demand for withdrawal. This fact, 
in its turn, limits the nature of the loan transactions, 
practically to one class — the stock exchange call loan. 

The Call Loan System — In ordinary stock exchange 
transactions, the buyer of shares does not pay the whole 
of the sum for the purchase himself. He pays a margin, 
amounting, let us say, to ten per cent. The broker 
negotiates a loan with the bank on the security of the 
shares. In the case of a loan of $100,000 the bank will 
probably require shares to the market value of at least 
$110,000. The difference is to protect the bank against 
a possible fall in the value of the security. In case the 
loan is defaulted, the bank has the right to sell the 
security and it must be sure that the security will 
realize sufficient to pay for the amount of money orig- 
inally loaned, together with the expenses of the trans- 
action. These loans are made " at call." That is, 
the bank has the right to ask for the payment of loan 
at any time. Thus, the deposited reserves of the 



218 AN INTRODUCTION TO ECONOMICS 

country are dependent, not upon the commercial se- 
curity of the country, but upon the stabiHty of the 
stock market, whose operations are more largely specu- 
lative than those of any other body. 

In normal times there is no doubt that the reserve 
system worked fairly satisfactorily. But a good re- 
serve system should not be dependent upon normal 
conditions. We do not ask for a fire protection sys- 
tem that works satisfactorily as long as the only fires 
that occur consist of the burning of waste-paper 
baskets. What is wanted is one which will take care 
of real fires. So in the case of a reserve system it 
must be judged by what it will do in times of crisis. 
And it is just in this respect that the National bank 
reserve system fails. 

Reserves during Crisis — Consider what happens 
in a crisis. Whether that crisis be caused by a stock 
exchange panic (which may be due to the work of 
manipulators) or by general business depression, the 
effect is the same. The prices of stocks fall. Now as 
soon as there are indications of the approach of a crisis, 
the banks require to increase their store of cash re- 
serves. To do this, they must call for the return of 
their deposited reserves. In order to repay the re- 
serves, the central reserve city banks must call their 
loans. In order to repay these loans, it is necessary 
for the brokers to sell their stocks. This means, how- 
ever, that the market is flooded with selling orders, 
with a consequent rapid and steady fall in prices. 
Some of the brokers are unable to meet their obligations. 
The banks, therefore, must sell the deposited stocks 
themselves. This in its turn increases the amount of 



THE AMERICAN BANKING SYSTEM 219 

selling orders and still further depresses the price of 
the stocks. The margin of security {i.e., the amount 
by which the security exceeded the amount of the 
loan) is soon wiped out and the stocks fall farther. 
Even if the banks can sell the stock, it is at a loss. 
The funds, therefore, are simply not available. 

In a crisis the result of this reserve system is that 
the only reserves which are really available for use 
are the cash reserves in the vaults of the individual 
banks. To these cash reserves, the banks in the 
soundest condition hold on tenaciously. Those which 
are weaker find them quite insufficient, and so are com- 
pelled to suspend payments in order that their de- 
positors may share equally in the total resources of 
the institution, and so equalize the loss. 

The account given above is not theoretical only. 
It represents what has happened time and again in 
American commercial history. The greatest panic 
of the last hundred years occurred in 1907. The 
results of the weakness of the reserve system were then 
made so obvious that some improvement was seen to 
be absolutely essential. Hence from that year until 
1913 investigations were made as to the best possible 
solution of the difficulty, and in 1913 Congress passed 
the Federal Reserve Act. How this new Act attempts 
to solve the problems arising out of the National bank- 
ing system will be considered in the next chapter. 



CHAPTER XVII 

THE AMERICAN BANKING SYSTEM (continued) 
The Federal Reserve Banks 

We have seen in the previous chapter that the 
chief faults of the National banking system lay in 
the methods adopted for securing a sound currency 
and in the manner of keeping reserves. It was the 
task of those who framed the Federal Reserve Act 
to remedy those faults. In order to understand the 
remedies enacted it will be necessary to anticipate 
a discussion which will be dealt with more fully in a 
later chapter. 

Control of Reserves by Individual Banks — The re- 
serves act as a sort of last line of defense in a panic. 
If they do not remain strong enough to satisfy the 
demands for return of deposits, nothing is left but 
suspension and failure. Before the necessity of draw- 
ing upon reserves appears, however, banks can obtain 
funds in several ways. They can stop lending money, 
for instance. If there is time available for collecting 
funds before the demands are too great, this method 
is bound to build up funds. Let us see how this 
occurs. The bank profits depend upon the interest 
received for loans. But loans are not indefinite. 
They are always made for a specified time or else 
at call. If the bank stops lending money, therefore, 

220 



THE AMERICAN BANKING SYSTEM 221 

it has only to await the maturity of the loans already 
made for the funds to begin to accumulate. Some 
will mature almost immediately, others more slowly, 
but gradually all will mature, and if the loans have 
been carefully made, the bank ultimately will have 
all of its funds intact. 

A sudden stoppage of loans, however, is bad from 
several different points of view. In the first place 
it is an indication of weakness on the part of the bank. 
Quite probably, therefore, it will bring about the 
very demands that it purposes to avoid. In the 
second place, it will result in serious inconvenience 
to business men who have been relying upon the possi- 
bility of obtaining loans for their commercial purposes. 
As we shall see later on, business is carried on mainly 
with borrowed money and a sudden stoppage of loans 
means a consequent sudden stoppage of business. 
Hence, from the point of view of the business man, 
such a sudden cessation of the power to borrow is to 
be avoided if it is at all possible. 

Use of the Discount Rate — Instead of a sudden 
stoppage, however, the stoppage may be more gradual. 
This may be secured by raising the rate of discount. 
Suppose there are two men each of whom has an oppor- 
tunity to make profitable use of a certain amount of 
capital, one expecting to gain seven per cent on the 
use of the capital and the other eight per cent. Now 
suppose, further, that each will borrow capital for 
the purpose of his transaction if he can secure a net 
return of four per cent. Finally let us suppose that 
the rate of discount is three per cent. This being 
the case, each can borrow the necessary capital, 



222 AN INTRODUCTION TO ECONOMICS 

paying three per cent for its use, one making a net 
profit of four per cent, and the other five. Now sup- 
pose the discount rate is raised to four per cent. In 
this case the man whose transaction will make a gross 
profit of seven per cent finds that if he borrows, his 
net returns will only be three per cent. By our hy- 
pothesis, however, that is too small a return to justify 
borrowing the capital. Hence he will not borrow. 
The other man, however, can still borrow and make 
his net profit of four per cent. The result of the rise 
in the discount rate, therefore, is to prevent one man 
from borrowing, without actually prohibiting him. 
One loan is made instead of two. This amounts, of 
course, to a gradual cessation of lending. 

From the business point of view, this means that 
the more profitable investment is carried out and the 
less profitable prevented. It is assumed that the 
more profitable is that one which is most required by 
the community, and therefore, while there is a certain 
amount of restriction in business, that which the 
community feels is more valuable is maintained and 
only the less valuable elements are dropped. 

This last argument must, of course, be interpreted 
very broadly, for there are many circumstances to 
be considered in estimating the value of a transaction 
to the public, besides the price the public is willing 
to pay. 

In each of the foregoing arguments, however, we 
have assumed that all the banks were affected equally. 
This is seldom the case, however. There are times 
when one bank has opportunities of making satis- 
factory loans to a much greater extent than others. 



THE AMERICAN BANKING SYSTEM 223 

Hence, we can often find instances where one bank in 
a particular district is compelled to refuse sound 
loans, while in another district there are banks which 
cannot find sufficient loans to employ their capital. 

Rediscounts — The remedy in these cases is simple. 
The bank which has too many loans on hand may take 
some of the notes which it has already discounted 
but which are not yet mature, and discount them 
again. Suppose the First National Bank of Chicago 
has opportunities for more loans than it has available 
funds to supply. The reason it has no funds is obvi- 
ously because it has already lent out its funds. The 
evidences of indebtedness, in the shape of discounted 
notes, drafts, etc., are still in the hands of the banks, 
and presumably will remain there until the loans 
mature. At the same time let us suppose that the 
Wells Fargo Nevada National Bank of San Francisco 
has funds for which there are no borrowers. There 
is nothing to prevent the First National of Chicago 
from discounting some of its notes with the Wells 
Fargo Nevada Bank. By so doing, the Chicago 
ban^ is able to satisfy its clients by means of the funds 
obtained, whije the San Francisco bank has employed 
some of its surplus funds. This process is called 
" rediscounting." For some reason the process has 
not recommended itself to business men in America 
until recent years. They have assumed that a bank 
which rediscounts its " paper " is in a weak condition. 
There is nothing, however, to justify that assumption. 

One of the great difficulties in the way of a satis- 
factory development of the system of rediscounting 
has been the lack of facility for bringing idle capital 



224 AN INTRODUCTION TO ECONOMICS 

to the place where it is needed. That is, in other 
words, there has been no "rediscount market." Had 
there been such a market, it is quite possible that the 
panics of the nineteenth century would not have 
been so severe as they were. At any rate, it may be 
remarked that nowhere in Europe, where the redis- 
count system is very highly developed, have panics 
been so severe as they have been in America. 

The Federal Reserve Act — With this as preface, 
we may now turn to the actual provisions of the Federal 
Reserve Act. The Act is the result of a careful exami- 
nation of the methods of banking in all the civilized 
countries. What has seemed adaptable to American 
circumstances and advisable from the point of view 
of American needs has been utilized in framing the 
Act. It starts out with an attempt at unifying the 
system. At the head of the system stands the Federal 
Reserve Board, This board consists of seven mem- 
bers, including the Secretary of the Treasury and the 
Comptroller of the Currency. The other five members 
are appointed by the President. The first duty of 
this board was to divide the country into twelve^ dis- 
tricts, called Federal Reserve districts.^ In each of 
these districts a Federal Reserve bank was established. 
The banks, however, although established by the 
federal government, do not belong to the govern- 
ment. Each National bank was compelled, under 
a penalty of losing its charter if it refused, to subscribe 
towards the capital of the Federal Reserve bank a sum 
amounting to six per cent of its capital and surplus. 
The directors of the banks are divided into three classes. 
In the first class are those who are appointed by the 



THE AMERICAN BANKING SYSTEM 225 

Federal Reserve Board. These are three in number 
and include the president and vice-president. These 
directors act as representatives of the board, so that 
the central control is well established. Another three 
of the directors must be men engaged in banking 
business. The remaining three must not be engaged 
in any banking business, but must be representative 
business men of the community in which the bank is 
situated. The manner of electing the six local direc- 
tors, as we may call them, is worth explaining. The 
banks in the Federal Reserve district which are 
members of the Federal Reserve system, that is, all 
the National banks in the district and those other banks 
and trust companies which have become members 
by complying with the necessary conditions, are listed 
in order of their capital. The list is then divided into 
three parts, each part containing the same number of 
banks. The first group has the privilege of electing 
one banker as a director, and one business man. The 
second and third have the same privilege. The reason 
for this mode of election is to insure the representation 
on the directorate of the Federal Reserve bank of the 
small and medium-sized banks as well as of the banks 
with large capital. 

The profits of the bank are apportioned as under 
any other form of corporate organization, but divi- 
dends are limited to six per cent of the capital. If the 
profits earned are in excess of six per cent, the differ- 
ence goes to the government. 

The Reserve System — - So much for the organiza- 
tion. We must now consider the principles upon 
which the system works, and we shall deal first with 



226 AN INTRODUCTION TO ECONOMICS 

the reserves. It will be remembered that the chief 
fault in the reserve system under the National Bank- 
ing Act was that the reserves were scattered through- 
out the country as far as the cash was concerned, and 
that the deposited reserves were concentrated in the 
New York banks, where they were almost invariably 
loaned out on call and were therefore dependent upon 
the speculative activities rather than the purely 
commercial. 

The Federal Reserve Act, as it is now, has changed 
somewhat from its original form, and there is no reason 
why we should spend time over the initial stages of 
development. Under the present form of the Act, 
the whole basis of the reserves has been changed. In 
the first place a distinction has been made between 
time and demand deposits. It is realized that when 
a banker may claim a certain amount of notice before 
being compelled to refund deposits, he does not need 
to maintain so large a reserve as if the deposits were 
withdrawable on demand. A decision had to be made, 
however, as to the exact meaning of the term time 
deposit as distinguished from demand. The dis- 
tinction is bound to be arbitrary, of course, but the 
Federal Reserve Board has laid it down that deposits 
which a bank accepts on condition that it may exact 
thirty days' or more notice before refunding, are con- 
sidered as time deposits. Those which may be with- 
drawn with less than thirty days' notice are demand 
deposits. 

The old nomenclature of Central Reserve Cities, 
Reserve Cities, and Country Banks has been retained, 
but a change has been made in the proportions of 



THE AMERICAN BANKING SYSTEM 227 

reserve against deposits. In central reserve cities 
a reserve of thirteen per cent must be maintained 
against demand deposits. In reserve cities the reserve 
minimum is ten per cent, while in country banks a 
minimum reserve of seven per cent is required against 
demand deposits. The proportion of reserve against 
time deposits is the same for all three classes, three 
per cent. A vital difference in the method of carrying 
the reserves must be noted, however. Only sums on 
demand deposit with a Federal Reserve hank may he 
counted as reserve. Cash in vaults is no longer recog- 
nized as a method of maintaining reserves. The 
Federal Reserve bank must maintain a cash reserve 
of thirty-five per cent against its deposits. 

It will be noted that under this system the reserves 
of the country are centralized, but centralized in dis- 
tricts. Each Federal Reserve bank is the custodian 
of the reserves for the whole of the district in which 
it is situated (excepting, of course, the reserves of 
non-member banks). Now the business done by the 
Federal Reserve banks consists mainly in the buying of 
commercial paper. That is, the Federal Reserve banks 
are dependent upon commerce rather than upon specu- 
lation. This in itself is a valuable improvement. 

The centralization of reserves, on a proper basis of 
commercial activity, remedies the defects which we 
saw in dealing with the National banks. We may 
no longer liken the reserve system to a fire system 
consisting of individual buckets only available in the 
rooms in which they are placed. Now it may be 
compared with a building in which there is a central 
tank, with pipes leading to all the rooms, the whole 



228 AN INTRODUCTION TO ECONOMICS 

1 

force being available for a fire which breaks out in a 

single room. The tank, too, if we may continue the 
simile, is always full. The reserves in the Federal 
Reserve bank are real reserves and are available 
when required. 

Rediscount Market — It is not necessary for the 
banks always to^ draw upon their reserves when they 
are called upon to refund money. The Federal Reserve 
system provides what was lacking in the older system, 
a rediscount market. Commercial paper may be 
rediscounted in the Federal Reserve bank provided 
it is not of longer maturity than ninety days. The 
expression " commercial paper " needs some definition. 
The primary transaction upon which all commerce 
rests is the purchase and sale of goods. When a 
merchant sells goods it is customary for a certain 
amount of credit to be given the customer, the length 
of credit varying with the nature of the business and 
the individual conditions of the transaction. Now 
the seller may not wish to lose the use of his capital 
during the life of the credit period. If he waits until 
the time is up before he receives his money, he cannot 
make any use of that money during the intermediate 
period. This means that he is acting as a banker 
to his customer and practically lending the customer 
the amount due for the length of the credit period. 

In order to obtain the money before his customer 
pays for the goods, he negotiates a loan with the 
bank. The evidence of the loan, in the form of accepted 
draft or promissory note, is termed commercial paper. 
The varieties of the forms of commercial paper need 
not concern us here. 



THE AMERICAN BANKING SYSTEM 229 

A note which is secured by the deposit of " col- 
lateral " in the shape of stocks and bonds, or by a 
real estate or chattel mortgage, is not considered com- 
mercial paper. Hence the notes which a stock broker 
signs when he obtains a loan on the security of the 
bonds which he deposits with the bank are not redis- 
countable at the Federal Reserve bank. 

Now let us suppose that a certain National bank 
finds its reserves in the Federal Reserve bank are 
falling close to the minimum. It does not need to 
call in its loans, or to stop lending. All that is necessary 
is that the bank take some of the notes discounted 
by it previously and rediscount these with the Federal 
Reserve bank. The proceeds, instead of being received 
in cash, will be credited to the deposit account of 
the National bank, so increasing its reserve fund. 

Crises and Panics — Now it is very important to 
realize that this process of rediscounting has a very 
great influence on the prevention of panics. Panics 
rise from many causes, but we may distinguish two 
important varieties. In the first place, there are 
panics which are purely the result of stock exchange 
movements which may be due to manipulations 
unconnected with the commercial prosperity of the 
country. The reserves, as we have seen, are not con- 
nected with stock exchange transactions. The more 
important cause of panics rests with the fluctuations 
of trade. Suppose a manufacturer sends out his sales- 
man at the beginning of a certain year, and finds that 
at first orders come in slowly. Little by little, how- 
ever, the orders increase. He begins to work his 
factory at full pressure. The orders continue to in- 



230 AN INTRODUCTION TO ECONOMICS 

crease in number and size. His factory works over- 
time. In order to obtain plentiful supplies of raw 
material, tie obtains loans from the banks. The 
banks, seeing that business conditions are good and 
that the manufacturer has every reason to suppose 
that he will be able easily to sell the goods he makes, 
are perfectly willing to lend the sums necessary. The 
manufacturer, with this additional capital at his 
disposal, increases his production. There comes a 
time, however, when the orders are not so easily 
obtained, and he must encourage sales by dropping 
prices a little. But he is only one of many. Other 
manufacturers are going through a similar experience. 
Hence there is a tendency to reduce prices all round. 
Suddenly, one manufacturer realizes that if he is 
to repay the sums he has borrowed, he must sell at a 
loss. The market has become overstocked and goods 
can only be sold at a sacrifice. The banks, looking 
to the safety of their funds, begin to call loans. If 
the credit has been too far extended there is every 
possibility of business failures and a commercial panic. 
Under the former system of banking, the difficulty 
was to know exactly vv^hen credit was overextended, 
and when business conditions really justified increases 
in credit. Under the Federal Reserve system there 
is a definite commercial pulse, as it were, which can 
be felt from day to day. 

The Discount Rate — The Federal Reserve banks, 
as we have said, must maintain a high reserve against 
their own deposits. If this reserve tends to fall toward 
the minimum, obviously rediscounts cannot be con- 
tinued at the same rate. The simplest method to adopt 



THE AMERICAN BANKING SYSTEM 231 

in order to cut down the amount of rediscounts is 
to raise the discount rate. Rediscounting will then 
be resorted to only by banks which really need funds. 
Those whose needs are not pressing will not redis- 
count. But the raising of the discount rate by the 
Federal Reserve bank is the signal for the raising of 
discount rates by the member banks. A fall in the 
reserves of the Federal Reserve bank, therefore, may 
be regarded as a sign of a tendency towards over- 
extension of credits. But as this fall is seen immedi- 
ately, steps can be taken to curtail credits by raising 
rates, and so the incipient panic is checked. 

Currency — The next important fault in the Na- 
tional banking system is the nature of the bank note 
currency. We have seen that this currency has no 
relation to the commercial needs of the country. It 
is based on the security of bonds deposited with the 
United States Treasury, and fluctuations in the value 
of the bonds affect the amount of notes in circulation. 
In order to secure a satisfactory currency, it is necessary 
that it be based upon the needs of commerce, increasing 
as the demands for currency increase and decreasing 
as the demands become less. 

Federal Reserve Notes — Two new forms of cur- 
rency paper are issued under the Federal Reserve 
Act, of which the more important are the Federal 
Reserve notes. These notes are based principally 
upon the commercial transactions of the country. 
Let us suppose that a merchant requires a loan from 
the bank of, say $10,000. This loan is for the purpose 
of making payments in small amounts, for wages, 
petty expenses, and so forth. To obtain the loan in 



232 AN INTRODUCTION TO ECONOMICS 

the form of a deposit credit necessitates the payment 
of the wages, and so forth, by check. This is not a 
satisfactory method in many places, as the workmen 
who receive the wages are not in the habit of carrying 
bank accounts. It is much more convenient to receive 
the money in the form of bank notes or government 
currency. The merchant, therefore, asks for the 
loan in the form of bank notes. Now it is quite possible 
that the bank has not the requisite amount of currency 
on hand. It can obtain the notes, however, by redis- 
counting the merchant's note at the Federal Reserve 
bank, receiving the rediscount payment in the form 
of Federal Reserve notes. These notes are secured 
by a gold reserve of forty per cent of the amount issued 
and by the commercial paper rediscounted. 

Of the forty per cent of gold, the Reserve bank can- 
not keep more than thirty-five per cent in its own 
vaults. Five per cent must be deposited with the 
Treasury to form a fund for the redemption of out- 
standing notes. 

How far are these notes an improvement over the 
National bank notes .f^ To answer this question we 
must look at the system from the points of view of 
(a) ultimate security, (b) immediate redemption, 
and (c) elasticity. 

In regard to the first point, ultimate security, it can 
readily be seen that there need be no apprehension on 
the part of holders as to the security. In the first 
place, there is the fact that at least forty per cent of 
the issue is definitely secured by gold. The remainder 
is secured by commercial paper. We must examine, 
therefore, the value of such paper as security. The 



THE AMERICAN BANKING SYSTEM 233 

commercial paper represents actual business transac- 
tions involving a necessity for currency. Before the 
banker makes the first loan he will scrutinize the 
transaction very carefully to see that there is every 
hkelihood of the fund for repayment being accumu- 
lated during the Hfe of the note. He only makes the 
loan when he is satisfied on this point. This means, 
then, that in the banker's opinion, a sound transac- 
tion in commerce is under way. It is possible, of 
course, that the transaction may fail; that the indi- 
vidual who owes the money may not be able to pay 
at maturity. In that case, the banker must have 
recourse to the resources of the borrower. The actual 
proportion of defaults on commercial notes is, however, 
very small. The chances of failure are less than one 
tenth of one per cent, i.e., less than one in a thousand. 
But the note is secured by more than the promise 
of the original maker. When it is rediscounted the 
member bank must place its own indorsement on the 
note. The Federal Reserve bank is therefore secured 
by the promise of the member bank, in addition to 
that of the original maker of the note. 

This reduces the possibilities of failure to a minimum. 
As far, then, as ultimate security is concerned, we may 
regard the Federal Reserve notes as being perfectly 
satisfactory. In regard to the immediate redemption, 
the same method is adopted as under the National 
bank system. A five per cent redemption fund, in 
gold, is maintained with the Treasury, and notes 
are cleared there in the same manner as are the National 
bank notes. 

The issue of the Federal Reserve notes is controlled 



234 AN INTRODUCTION TO ECONOMICS 

by the Federal Reserve Board, through its repre- 
sentatives on the directorate of the Federal Reserve 
bank. The chairman and vice-chairman of the 
board of directors are known respectively as the 
Reserve Agent and Deputy-Reserve Agent. It is 
their duty to obtain from the Federal Reserve Board 
the Federal Reserve notes and to issue these to the 
Federal Reserve bank as required. The gold and 
commercial paper which secure these notes are placed 
in the care of the Reserve Agent, who must always 
see that the paper is of the kind designated by the 
Board as suitable for security and that the gold fund 
is kept up to the minimum required by the Act. 

In the next chapter we shall consider the Federal 
Reserve notes from the point of view of an elastic 
currency. 



CHAPTER XVIII 

THE FEDERAL RESERVE SYSTEM (continued), WITH 
A NOTE ON THE CANADIAN BANKING SYSTEM 

Elasticity of Currency — Let us imagine a transac- 
tion in the ordinary business of commerce. Suppose 
a merchant has sold $10,000 worth of goods to one 
of his customers on the basis of thirty days' credit. 
The customer gives his note at thirty days in payment. 
The merchant discounts this note at the bank in order 
to obtain funds for the payment of ordinary current 
expenses in the way of wages, and so forth. He asks 
the bank for cash instead of deposit credit. In order 
to obtain the cash, the bank rediscounts the note with 
the Federal Reserve bank of the district and obtains 
Federal Reserve notes, which are paid over to the mer- 
chant. The note, upon which the loan is based, is 
now in the hands of the reserve agent of the Federal 
Reserve bank. The Federal Reserve notes are in 
general circulation. During the thirty days, which is 
the length of the credit period, the notes are continually 
passing from hand to hand. The customer, however, 
is gradually selling the goods, receiving in payment, 
we may suppose, Federal Reserve notes, which he de- 
posits with his bank. 

At the end of the thirty days, when the note is 
mature, the reserve agent calls upon the bank which 
indorsed the note to repay the loan. Usually, the 

235 



236 AN INTRODUCTION TO ECONOMICS 

Federal Reserve bank will send the note to the mem- 
ber bank for collection. The member bank, there- 
upon, sends the note to the man who signed it origi- 
nally, that is, the customer who has been selling 
the goods during the preceding thirty days. He pays 
the amount by drawing upon the money he has de- 
posited in his bank. This money is represented, we 
may assume, by the Federal Reserve notes collected 
in payment for the goods. In turn these notes are 
handed to the bank, which then turns them over to 
the Federal Reserve bank. The Reserve bank, there- 
fore, has received back the notes which it issued on 
the security of the commercial paper, and this, being 
paid, is now canceled. At the same time, the Reserve 
notes are also retired from circulation. 

To sum up the whole transaction, therefore, we may 
say that the sale of the $10,000 worth of goods gave 
rise to the provision of the amount of currency neces- 
sary to finance the operation. As soon as the sale 
is consummated, the goods in the hands of the ultimate 
consumers, and the payment received, the currency 
which was issued is canceled. 

It must not be supposed, of course, that this transac- 
tion represents the actual facts of every case. Obvi- 
ously the same identical notes which are issued by the 
Federal Reserve bank are not returned for final 
retirement. The actual process is a little more com- 
plicated, but essentially, the description given above 
represents the facts. With every issue of Federal 
Reserve notes, there is a corresponding amount of 
commercial paper. With every cancellation, by pay- 
ment, of such commercial paper, there is a correspond- 



THE FEDERAL RESERVE SYSTEM 237 

ing retirement of Federal Reserve notes. This answers 
the criticism which has been leveled at the system by 
certain English writers — the criticism that the Federal 
Reserve notes represent inflation of the currency. 

It must now be obvious that the issue of notes 
depends upon the existence of a commercial transac- 
tion which necessitates the currency, and that as 
soon as the commercial transaction is completed the 
notes are almost automatically retired. The system 
provides an elastic currency which fluctuates accord- 
ing to the needs of the community. The only point 
at which there is evidence of inflation is the fact that 
the Federal Reserve notes form an addition to the 
National bank circulation, and not a substitute for 
it. If the National bank circulation is left untouched, 
then it would appear that the total currency is in- 
creased by just the amount of Federal Reserve notes 
which are in circulation. It was the intention of 
those who designed the Federal Reserve Act, however, 
that the new currency should be a substitute for the 
National bank notes, and not an addition. Provisions 
had to be made, therefore, for the retirement of at 
least the greater part of the National bank notes. 

Federal Reserve Bank Notes — Now, as we have 
already seen, the National bank notes are secured 
by the deposit of United States Bonds. We have 
also seen that one of the provisions of the National 
Banking Act compelled all National banks to pur- 
chase a certain amount of government bonds, whether 
they intended to issue notes or not. This provision 
was repealed by the Federal Reserve Act and so there 
is no reason why the National banks should issue cur- 



238 AN INTRODUCTION TO ECONOMICS . 

rency. The currency cannot be retired, however, 
without seUing the bonds which act as security for 
the issue. But the price of these bonds (which are 
mainly two per cent bonds) was only maintained 
at par because of the demand for them as security 
for note issues. Now that the reason for this demand 
has ceased, it would seem that the bonds would fall 
to their normal level for gilt-edged securities paying 
two per cent. This level is considerably below par. 
Therefore, unless a special market is provided for the 
sale of such bonds, the banks in self-defense will be 
compelled to maintain their issues until the maturity 
of the government bonds, for if they sold them, they 
would suffer considerable loss. 

The Federal Reserve Act provides such a market 
in the following manner : 

Any bank which wishes to retire part of its circulation 
may sell its bonds to the Federal Reserve Bank at 
par. The Federal Reserve banks are compelled to 
take not more than $25,000,000 of these bonds each 
year. The total bond sales are proportioned among 
the twelve Federal Reserve banks. 

It might, of course, involve the Federal Reserve 
banks in considerable loss if they were compelled to 
purchase bonds to this extent and tie up their capital. 
The Act, however, provides that, if they think fit, 
the Federal Reserve banks themselves may issue cur- 
rency notes, which are termed Federal Reserve Bank 
notes, to distinguish them from Federal Reserve notes, 
against the security of the bonds so purchased. If, 
however, the Federal Reserve banks do not wish to 
insure currency on this basis, they may exchange the 



THE FEDERAL RESERVE SYSTEM 239 

bonds for three per cent gold bonds without the priv- 
ilege of issue. The extra one per cent compensates 
the bank for the loss of the issue privilege. 

The gold bonds received in exchange for the old 
two per cent bonds are divided into two classes. Half 
of them mature in thirty years. The other half 
mature in one year, but the Treasury has the right to 
renew them from year to year, but not for more than 
thirty years. In practice, very few of the Federal 
Reserve banks have issued notes based on the bond 
security, and the probability is that by the end of the 
thirty-year period the only bank notes in circulation 
will be the Federal Reserve notes. 

Summary — We are now in a position to sum up 
the effects of the Federal Reserve Act. It has, in 
the first place, compromised between the idea of a 
National central institution and the entirely unrelated 
institutions which preceded it. There are now twelve 
banks which act as central banks for the different 
districts. In so doing, they provide a sort of clearing 
house for country checks and so extend the clearing 
house system beyond the limits of the cities. Still 
further to extend this system, the Federal Reserve 
Board itself acts as a clearing house for the whole 
of the country. 

The reserves are placed upon a sounder basis and 
are entirely divorced from the speculative element 
in finance. They are based upon commercial opera- 
tions entirely and this eliminates one of the factors in 
the production of commercial crises. The reserves are 
more economical to the institutions than under the 
old system, despite the fact that the Federal Reserve 



240 AN INTRODUCTION TO ECONOMICS 

banks do not pay any interest upon deposits, while 
the National banks were in the habit of paying, as a 
rule, two per cent interest upon bankers' deposits. 
To illustrate this, let us consider the case of a country 
bank whose deposits amount to $100,000. 

Under the National banking system the reserves 
to be maintained against this amount would be $15,000. 
Of this amount, however, $9,000 might be placed on 
demand deposit with a National bank in a central 
reserve city, and earn two per cent. The cost of 
keeping reserves may be estimated as the amount 
which the reserves would earn if placed out at interest 
at the prevailing rate. Let us suppose that, during 
the year, the average rate of interest earned is five 
per cent. The loss of interest on the $6,000 cash 
reserve would be $300. As the $9,000 deposited 
reserves would earn interest at the rate of two per 
cent, the net loss is three per cent, or $270, making 
a total net loss of $57p. The interest earned on the 
balance of $85,000 deposits would be $4,250. 

Now under the Federal Reserve system, the first 
fact to be noticed is that a distinction is made between 
the demand and time deposits. On the average, a 
country bank has twice as much demand deposits as 
time. To be on the safe side, let us suppose that the 
deposits are divided into seventy per cent demand 
and thirty per cent time. Against the time deposits a 
reserve of three per cent is maintained. This amounts 
to $900, the loss of interest on which, at five per cent, 
amounts to $45. Against the demand deposits a 
reserve of seven per cent is kept, amounting, in this 
case, to $4,900. The loss of interest on this sum 



THE FEDERAL RESERVE SYSTEM 241 

amounts to $245, making a total net loss of $290 as 
against $570 under the National banking system. 
But the amount of earning deposits under the Federal 
Reserve system is $94,200 as against $85,000 under 
the National banking system. This means a possi- 
bility of net earning of $4,710 instead of $4,250. 

In regard to economy of funds, therefore, the Federal 
Reserve system has very considerable advantage over 
the older method. 

The currency system is much improved by the new 
Act. Instead of a currency which is, in spite of its 
soundness as far as par value is concerned, perversely 
elastic, we have a currency which is equally sound 
and yet directly elastic, in that it comes into exist- 
ence only when commercial transactions demand the 
additional notes, and when those transactions are 
completed, the currency is almost automatically re- 
tired. 

Perhaps the most important of all the improvements, 
however, lies in the definite establishment of a redis- 
count market. This enables the Federal Reserve 
Board to keep its finger upon the commercial pulse 
and to know when credit conditions are becoming 
unduly extended long before that extension assumes 
dangerous proportions. 

The fact that the Federal Reserve Board may defi- 
nitely stipulate what kind of paper it will accept for 
rediscount purposes renders it possible to educate 
business men into the use of the most satisfactory 
methods of financing their business. 

Finally we must mention the method of control 
of the whole of the member banks. In the case of 



242 AN INTRODUCTION TO ECONOMICS 

a National bank, as we have seen, the government 
provided for periodical examination. This is done , 
also under the Federal Reserve system, but the exami- -] 
nations are a little more stringent. Provision is made 
against what is known as " window dressing." Sup- 
pose a bank is ordered to report the state of its affairs 
on the sixth of June and receives the notice a month 
before that date. In the interval there is time for 
the bank to close out some of its weaker loans, 
strengthen its reserve, examine its collateral, and see 
that all securities represent sound values. By the 
time the date of the report arrives, the condition of 
the bank is such that it will present a very favor- 
able report. This is avoided by the Federal Re- 
serve Board asking for reports for a day which has 
already passed. Five reports are to be made each 
year and the Board may ask for these at its own 
convenience. 

There is also an examination necessary before any 
new bank is admitted into the system, in order that 
only sound institutions shall be maintained. 

In short, the United States has now a banking sys- 
tem which will compare with the best existing any- 
where. It is, of course, not perfect but it represents 
a wonderful improvement upon that which preceded 
it. As to its actual working, the system has been in 
operation for too short a time to pronounce a definite 
verdict, but it may be said that up to the present 
the faults which have developed are comparatively in- 
significant and the system has stood a strain which 
financial institutions are very seldom called upon to 
stand. 



THE FEDERAL RESERVE SYSTEM 243 

Note on the Canadian Banking System 

The banking system of Canada has long been recog- 
nized as exceptionally strong. It differs very ma- 
terially from that of the United States, whether we 
consider the National banks or the Federal Reserve 
system. Canada has no great central bank, but, on 
the other hand, it does not have a great number of 
small, or comparatively small banks. . There are 
about thirty banks in the Dominion which have received 
a government charter. These institutions have their 
headquarters usually in the city from which they 
receive their name. But they are represented through- 
out the country by great numbers of branches all in 
close connection with the parent institution. In this 
way, each of the parent banks acts as a sort of central 
institution in much the same way as the Federal 
Reserve bank acts in the United States. 

The relation is even closer, however, for the central 
bank gives very close supervision to the acts of the 
branches, controls the reserves, and distributes the 
funds where they will do the most good. There is 
no reason why there should be idle funds while the 
business of the community shows the necessity for 
loans to be made. If business is dull where one 
branch is situated, other branches can make use of 
the spare funds. From the point of view of account- 
ing, the system has the great advantage of a uniform 
method. Hence the statistics of banking are in a 
much more satisfactory condition than they are in 
the United States, although under the new organiza- 
tion in this country a much closer approach to stand- 



244 AN INTRODUCTION TO ECONOMICS 

ardization of method is possible now than under the 
jld banking act. 

The system of bank examinations in Canada is, 
or perhaps it is better to say was, much more strict 
than in our country. This was perhaps due in a large 
measure to the fact that the examiners are paid on 
a different basis from those who acted under the Na- 
tional Banking Act. Under the latter system the 
examiners were paid so much for each bank examined. 
Hence it was to their advantage to examine as many 
institutions as possible, and this tended to lax methods. 
In Canada the examiners receive a stated salary no 
matter how many banks they examine. A typical 
example of the difference in examinations may be 
mentioned. An American banker who had the oppor- 
tunity of watching an examination conducted into the 
affairs of a branch of a Canadian bank in the United 
States, was amazed at the thoroughness with which 
every roll of coins was examined. In his own bank 
he had found it customary for the bank examiner to 
take the figure on the roll as representing the contents. 
The Canadian examiner opened every roll and counted 
every coin. 

The Canadian banks are not unrelated to each other. 
The banks have formed an association which acts in 
a certain degree as the Treasury does for the National 
banks. The important function of this association 
is the clearing of the various issues of bank notes. 
The Canadian banks are not restricted in regard 
to the amount of notes which they may issue, and 
there are no bonds to be deposited as security. The 
notes themselves form a first lien upon the assets of 



THE FEDERAL RESERVE SYSTEM 245 

the bank. Every bank, however, is compelled to 
maintain a fund for the redemption of its notes. This 
fmid, which amounts to five per cent of the circulation, 
is placed in the hands of the Minister of Finance. 
The association clears the notes which come up for 
redemption, and the ownership in the fund varies 
according to the amount which is presented for redemp- 
tion. 

In the case of the failure of a bank, its outstanding 
notes commence to bear interest at the rate of six 
per cent at once. Hence they are eagerly sought as 
an investment, and in a very short time pass out 
of circulation. The notes are redeemed from the 
central fund, no matter how small the amount owned 
by the defunct bank. The assets of the bank when 
realized must make good the amount paid out of the 
fund in excess of the five per cent placed originally 
by the bank. 

The fact that each of the banks may possibly be 
called upon to supply a deficit in case the assets of 
the bankrupt institution are not sufficient to pay 
for the outstanding notes, gives each bank an interest 
in seeing that no institution over-issues its notes. 

The actual control of the banks is left very largely 
in the hands of the bankers themselves, but experi- 
ence has proved that in this case, at least, the bankers 
have justified the confidence placed in them by the 
government. 

The difficulties which the National banks experienced 
in regard to the lack of an efficient rediscount system 
have not arisen in Canada, because of the branch 
system. The parent bank naturally acts as the re- 



246 AN INTRODUCTION TO ECONOMICS 

discounting bank, but with the advantage that there 
is no rediscount rate. Any branch bank which requires 
additional funds has merely to call upon its head 
office, which may withdraw funds unused by other 
branches. 



CHAPTER XIX 

THE NATURE AND MECHANISM OF TRADE 

The Nature of Trade — It has been made abun- 
dantly clear in previous chapters that trade consists 
essentially in the exchange of goods and services for 
goods and services. It is necessary, however, to 
examine this proposition a little more closely than 
we have been able to up to the present. There are 
considerable difficulties involved in realizing that 
money is merely an intermediary and not a prime 
necessity. When a tailor makes a suit of clothes he 
expects to receive money in exchange for it. When 
the grocer renders his monthly bill, he expects to be 
paid in some form or other of money. When the 
workman has finished his weekly work he demands 
money in payment for that work. Money is, of 
necessity, so closely associated with the reward for 
labor, or the quid pro quo in an exchange, that it 
inevitably tends to be regarded as a good in itself. 
It is, of course, true that standard money is a good 
in itself in that it possesses a value as a commodity, 
apart from its value as a means of facilitating exchange. 
But the greater part of the money instruments in 
use to-day have no intrinsic commodity value. 

It is so very difficult to realize in practice that a suit 
of clothes is worth, let us say, a week's work, or a six- 
hundred-mile railroad journey, that it is almost always 

247 



248 AN INTRODUCTION TO ECONOMICS 

preferable to speak of it as being worth so many dollars. 
But when we say so many dollars we are obscm*ing 
the facts and not simplifying them. The appar- 
ently more difficult form of expression in terms of a 
week's work, or a journey by rail, is really more 
accurate. 

When Tom Smith gives a week's work in return for 
$25, he is really working for so much food, shelter, 
clothing, amusement, education, and so on. He can- 
not, of course, give part of his work to the clothier, 
another part to the house-builder, a third to the grocer, 
and so on. Or, at least, it is not readily apparent 
how he can do so. In reality he must give those who 
build his house and provide his food and clothing the 
results of his work. The function of trade is to facili- 
tate this process. 

We have already seen that each produces more of 
a certain requirement than is necessary for his own 
consumption. Indeed it is quite possible that many 
will spend their whole time in producing some commod- 
ity for which they have personally no need. Examples 
of this are easy to suggest — a teetotaler working in 
a brewery, a surgical-instrument maker who is not 
a surgeon, an optician whose own eyes are perfect. 
Nevertheless, each is engaged in producing something 
which is desired by somebody. Trade arises in the 
necessity that each should get as much as possible 
of what he desires, and should concentrate his energies 
on the production of some one article which is desired 
by others. 

The more easily the necessary exchanges are effected, 
the greater is the likelihood that all will be satisfied, 



THE NATURE AND MECHANISM OF TRADE 249 

or that all can be satisfied. The student must remem- 
ber, of course, that we are not dealing with the relative 
amounts of goods and services received by each mem- 
ber of the community. That is a totally different 
problem. At present we are simply concerned with 
the mechanism of the process, not with the ethics 
of the distribution. We shall consider the question 
of the distribution, or allocation of the products of 
industry, in a future section of the book. 

The Mechanism of Exchange — To turn, then, to 
the question of this mechanism of exchange : we have 
to consider the fundamental provision of a means of 
offsetting the products of one man's labor against 
those of another man. At the present time, although 
we constantly speak as if every obligation of a com- 
mercial nature was solved by the use of money, as 
a matter of fact money comparatively seldom enters 
into the matter at all. A complex system of book- 
keeping transactions takes its place. We have not 
space to analyze this system carefully, but we may 
obtain a sound idea of the nature of its work by con- 
sidering the processes through which most common 
business transactions pass. 

We shall assume, at the outset, that the banks may 
be regarded as a single institution. The reasonable- 
ness of this assumption is obvious from the study of 
the chapters on banking. Now let us suppose that 
the Electric Hardware Company desires to purchase 
a supply of copper wire, nickel, steel, rubber, and 
silk for the purpose of carrying out its manufacturing 
program. These goods must be paid for. If "cash" 
is demanded, the Electric Hardware Company forwards 



250 AN INTRODUCTION TO ECONOMICS 



1 



its check to each of the various dealers as payment. 
These checks are in turn deposited by the copper, 
nickel, steel, and silk dealers with the banking system 
where, for the present, we shall leave them. 

The Trade Acceptance — Meanwhile the hardware 
company proceeds with its manufacture and turns 
out electric irons, toasters, heaters, percolators, and 
so on, as required in the market, or, at least, as the 
company thinks they are required. Its salesmen trav- 
eling throughout the country dispose of the products 
to the local dealers, giving, let us say, sixty days' credit. 
The Electric Hardware Company, however, must have 
" cash " with which to pay its workmen. It is quite 
possible that its balance at the bank is nearly ex- 
hausted by the checks drawn in payment of the 
copper and nickel bills. In order to obtain the re- 
quired funds it is necessary to anticipate the pay- 
ment of the goods sold to the retail dealers. There are 
many different ways in which this anticipating may 
be done, and it is impossible to outline all. Let us take 
the method which will, in all probability, be the one 
adopted in ninety-nine cases out of a hundred within 
the next few years — the method of the " Trade Ac- 
ceptance." At the time the Electric Hardware Com- 
pany dispatches the goods to the retailer, let us say to 
the Jonesville Hardware Store (W. Thomson, proprie- 
tor), it makes out a draft somewhat as follows : 



THE NATURE AND MECHANISM OF TRADE 251 

$500.00 Dayton, Ohio, January 10, 1919. 

To The Jonesville Hardware Store, 
Wm. Thomson, Proprietor, 
Jonesville. 
Pay to the order of the First National Bank, Dayton, 
Ohio, the sum of Five Hundred Dollars sixty days after the 
date hereof. 

This acceptance arises out of the sale and purchase of 
Electrical Goods invoiced January 10, 1919, for the sum of 
$500 and sold to the Jonesville Hardware Store. 

The Electric Hardware Company, 

Per J. Smith, President. 

In this particular illustration we will assume that 
the goods have been sold on the basis of accepting the 
draft immediately upon receipt of the goods. This 
is not by any means always the case, but the methods 
are so numerous that we may as well take one as 
another, especially as the particular method does not 
affect the principle. The draft is sent, with the 
invoice of the goods, to Thomson of Jonesville, who 
writes across the face of the draft the words " Accepted, 
payable at the Merchants' Bank, Jonesville," and 
signs his name. The document is now known as an 
" acceptance " and is returned to the Electric Hard- 
ware Company. The latter company now takes the 
acceptance to its bank and discounts it, obtaining 
the discount in the form of an increase in its de- 
posit credit. The hardware company can now draw 
checks against this new deposit credit with which to 
pay such current expenses as light, heat, insurance, 
wages, and so forth. Meanwhile the Jonesville Store 
is busy selling the goods. Most of the customers 



252 AN INTRODUCTION TO ECONOMICS 

will pay in notes; some by check; a few, possibly, 
in cash (according to the price of the different articles). 
Thomson deposits the funds thus obtained in his bank 
in order to meet the acceptance when the sixty days 
are up. 

At the end of the sixty days, the First National 
Bank of Dayton forwards the acceptance to its agent 
in Jonesville, who presents it for payment to the Mer- 
chants' Bank. The latter informs Thomson that his 
acceptance has been presented for payment and 
requests instructions, in case it has not already received 
these instructions. Thomson then tells the bank to 
pay the acceptance and to charge his account. The 
Merchants' Bank pays the agent of the First National 
of Dayton (perhaps it is itself the agent), who in turn 
credits the First National with the amount. 

The whole transaction is now complete, and the 
student can readily see that little or no cash has been 
involved. What has actually happened, however, 
is that certain copper miners, steel workers, and so 
on, have been enabled to obtain food and clothing ; 
the product of their labor has resulted in the provision 
of raw material for other workmen who, in turn, have 
received the equivalent of food, clothing, and so on. 
Their work has passed into the hands of a retail dealer, 
who, in return for the means of purchasing his own 
food and other requirements, has passed the goods 
into the hands of the ultimate consumers. In this 
manner the whole transaction, or series of transactions, 
is completed. The part played by the banking system 
is important. Without the interposition of the banks, 
there would be hardly any possibility of financing 



THE NATURE AND MECHANISM OF TRADE 253 

the different stages of the process of exchanging the 
products of the miner and the smelter for those of 
the grocer and butcher. And yet the banks them- 
selves produce no commodity; they merely facilitate 
the exchanging of commodities. They act, it may 
be said, as the limestone which is used in smelting 
iron. The iron ore could be smelted at a very high 
temperature without the use of the limestone "flux, " 
but by using the limestone, which is not altered in 
the process, the ore is melted at a much lower tempera- 
ture. The banks act as the flux of trade. 



CHAPTER XX 
INTERNATIONAL TRADE 

Meaning of the Word International — In the last 
chapter we considered the question of the process of 
trade between individuals, and we saw that in this 
trade the essential process is the exchange of goods 
and services for goods and services, or, in other words, 
the exchange of utilities. Is there any essential differ- 
ence between the processes of trade between individ- 
uals and between nations ? It is fair to say that there 
are no fundamental differences, but in spite of this 
there are sufficient modifying influences to make it 
worth while to give special and separate attention to 
the question of international trade. 

Definition of Nation — Our first difficulty is to define 
exactly what is meant by a nation. Are we, for in- 
stance, to regard each state of the Union as a sepa- 
rate nation or merely as one part of the nation? 
Do Canada, South Africa, and Australia form separate 
nations or are they part of the British nation.'^ To 
answer these questions properly it is necessary to dis- 
tinguish between the political point of view and the 
economic. A nation, in the political sense of the term, 
is a group of individuals who have been and are asso- 
ciated with one another, who are conscious of a unity 
secured by the ties of a common language, common 
history, common religion, or common government, or 

254 



INTERNATIONAL TRADE 255 

by a combination of two or more of these. From the 
poHtical point of view, therefore, the British colonies 
form part of the British nation, and the States of the 
Union are part of the American nation. 

The ties which bind together the members of the 
poHtical nation are, however, not the same as those 
which bind the members of the economic nation. 
Geographical considerations play a much more impor- 
tant part. In the case of domestic trade, as we have 
already seen, there is a comparative freedom of motion 
for labor and capital which tends, on the whole, to 
keep those factors of production fluid. Capital, 
however, is always somewhat more fluid than labor. 
The wider the market the less apparent is the fluidity. 
But this applies much more to labor than to capital. 
Ties of home and kindred hold the workman in one 
place, or within a comparatively short radius of one 
place, when economic motives tend to make him move. 
The essential factor, then, which distinguishes one 
economic nation from another is a comparative im- 
mobility of labor and capital. The distinction is often 
enforced by more artificial bars to exchange, as in 
the case of prohibitions and customs duties, as well 
as by the mechanical difficulties caused by different 
coinage and currency systems. 

From this point of view, while we should still regard 
the states of the Union as forming part of the same 
nation, economically it is better to assume that the 
colonies of Great Britain are separate nations. Their 
distance from the home country and from each other 
renders labor comparatively immobile, and, to a 
less extent, capital also. Their currency systems are 



256 AN INTRODUCTION TO ECONOMICS 

not always the same as that of the mother country 
and the artificial hindrances of protective duties tend 
also to distinguish the nations. 

Essentials of International Trade — It is important 
to recognize that the fundamentals of international 
trade do not differ from those of domestic trade. 
Utilities are still exchang-ed for utilities. International 
trade is not merely the bartering of goods for goods. 
We use the word barter advisedly, although foreign 
trade is carried on under a system of credit and money 
economy. The function of the money and credit 
system, however, is, as we have seen, merely to lubri- 
cate the process of exchange, and the lubricant does 
not alter the real nature of the process. 

Law of Comparative Cost — Exchange of any kind 
only results when two parties are unsatisfied with 
their present possessions and are unable to supply 
their owti additional requirements cheaply enough 
themselves. If each individual by his own unaided 
efforts were able to satisfy all his wants, there would 
be no trade at all. But we have seen that even if 
each individual does provide all his own necessities, 
the method is wasteful, for it does not take advantage 
of the economies of division of labor. A successful 
lawyer may be able to type his own briefs and letters. 
He does not do so, however, because he can employ 
his time more profitably in other w^ays. The same 
is true of a nation. It is possible for England, for 
instance, to rear silkworms and so to produce its own 
raw material for silk. It is also possible for France 
to produce cotton and woolen goods. But in each 
case the capital and labor employed would not earn 



INTERNATIONAL TRADE 257 

SO much as by being applied in England, say, to the 
production of cottons and woolens, and in France 
to the production of silk, the surplus products in each 
case being exchanged. 

In order to make this clear, let us suppose that 
there are only two countries, A and B, engaged in 
trade, and that they actually only produce two commod- 
ities, wool and silk. And let us further suppose that 
in A the application of a given amount of labor and 
capital (which we may call a unit of production) will 
produce ten yards of woolen cloth and a similar unit 
of production will produce five yards of silk. In B 
a unit of production will produce ten yards of wool and 
fifteen yards of silk. 

Now if each of the two countries produces both 
wool and silk, there will be a total production of 20 
yards of woolen cloth and 20 yards of silk. It is 
obvious, however, that a better total result will be 
obtained if A specializes in woolen cloth and B in 
silk. In that case the total production will be 20 
yards of woolen cloth and 30 yards of silk. There 
would thus be a profit for the communities of both 
countries of 10 yards of silk. 

Taking into consideration, therefore, the purely 
economic reasons, there is a considerable profit in 
this " territorial division of labor " as international 
trade has well been called. The very existence of 
international trade shows that this profit is realized. 

Benefits of International Trade — It is obvious 
from the above brief account of the influence of com- 
parative cost upon production that there is a definite 
increase in total product when the separate nations 



258 AN INTRODUCTION TO ECONOMICS , 

4 

specialize in the products for which they are most 
suited. This definite increase would be utterly im- 
possible without the development of international 
trade. Just in the same way, the increase in product 
due to specialization in labor gave rise to domestic 
trade. 

The great benefits to be derived from international 
trade, therefore, are due to the extension of the prin- 
ciple of division of labor to the territorial division of 
labor, which is the essence of international trade. 
It means an increased economy in the use of labor 
and capital. The problem which is set to humanity 
is to make the most of the natural resources of the 
world. Anything which tends to increase the total 
returns from the application of the agents of produc- 
tion to the natural resources of the earth, to that 
extent benefits humanity. 

It must not be thought that this is merely a theo- 
retical discussion without basis in actual fact. The 
truth of the theory can be illustrated from the cir- 
cumstances of any country which does any foreign 
trade at all. We have only eliminated certain com- 
plications due to the fact that international trade is 
seldom, if ever, between two countries only. The 
trading is triangular or even more complicated still. 
Let us take the case of the foreign trade of the United 
States. The materials which constitute the content 
of the foreign trade of this country may be divided 
into raw materials, or crude products, foodstuffs, 
and manufactured products. In 1914 (i.e., before 
the outbreak of the war) the exports of the United 
States were very largely divided between Europe and 



INTERNATIONAL TRADE 259 

North America, sixty-three per cent going to Europe 
and twenty-two per cent to North America. The 
imports came from Europe, North and South America, 
and Asia, the rough proportions being forty-seven 
per cent from Europe, twenty-two per cent from North 
America, eleven per cent from South America, and 
fifteen per cent from Asia. 

Our exports to Europe consisted largely of raw 
materials and foodstuffs and our imports from that 
quarter, of manufactured goods. We imported from 
the other countries raw materials and exported manu- 
factures. Now it is quite possible, for instance, for 
Great Britain to feed all her own population, as far 
as cereal foodstuffs are concerned, from her own agri- 
cultural area. It has been calculated that, with 
modern methods of intensive agriculture. Great Britain 
could feed a population of eighty millions, or nearly 
twice her present population. Britain does not do 
so, however, for she finds it better and more profitable 
to devote her attention very largely to manufacture, 
and to rely upon the United States, Canada, Australia, 
and Russia for her wheat. The other countries find 
it better to devote their energies and facilities to the 
production of these foodstuffs and to rely upon Great 
Britain, or upon the United States for manufactures. 
It will be obvious to the student now that our original 
hypothesis covers the actual facts. 

The war has produced a very natural effect upon 
the exports of this country. Much of the capital 
of Europe has been diverted from its ordinary com- 
mercial and industrial channels into the manufacture 
of war materials, and this has thrown the burden of 



2G0 AN INTRODUCTION TO ECONOMICS 



manufacture upon this country. Even in the manu 
facture of war materials the resources of the warring 
countries were not sufficient in themselves to supply 
the immense quantity of arms and ammunition re- 
quired, and hence the United States has also made 
large exports of these commodities. About half 
the increase in our exports of the last year (1918) 
consisted of war materials and the other half com- 
prised manufactured articles which the European 
countries would otherwise have made for themselves. 

It is true, of course, that a considerable proportion 
of this increase in exports is temporary, as it is due 
simply to war conditions. But there is a strong 
probability that much of it will remain, owing in a 
large measure to the increased facilities for production 
which the forced activities of the past few years have 
produced. 

Theory of International Value — We must now con- 
sider the question of the division of the benefits result- 
ing from the territorial division of labor. In all ex- 
change there is a certain rnutual advantage, as we have 
seen in a previous chapter. Exchange will not take 
place unless each of the parties conceives that he is 
being benefited. Apart, however, from this inevitable 
mutual advantage, we must consider the actual pro- 
portionate division of the increased product. 

Let us recur to our original hypothesis. In the 
two countries, A and B, we found that, if the law of 
comparative cost is actually carried out, there will 
be a total increase of product amounting to 10 yards 
of silk for every 4 units of production. How is 
that 10 yards to be divided .f^ Will it go entirely to 



\ 



INTERNATIONAL TRADE 261 

A which produces no silk at all, or will only the amount 
(five yards) which A could have produced itself be 
exchanged for the 10 yards of woolens which A has 
actually produced in addition to its own requirements ? 

There are many considerations to be noted before 
a definite conclusion can be arrived at. In the bar- 
gaining between two individuals much depends upon 
the comparative knowledge and skill displayed by 
two in determining the rate of exchange. In any 
individual case it is almost impossible to forecast 
what the rate will be. In taking the case of trade 
between communities, however, the matter is some- 
what easier, for the individual variations in knowledge 
and ability are canceled according to the law of 
averages. In any case, however, there are certain 
limits. In our particular illustration, we have in A 
a surplus of 10 yards of wool and in 5 a surplus of 
15 yards of silk. A will certainly not accept less than 
5 yards of silk for its 10 yards of wool, for it would 
prefer to apply the labor which produced the wool 
to the making of silk and thus obtain the 5 yards. 
On the other hand, B will not give more than 15 yards 
of silk for 10 yards of woolens, for it could produce 
the 10 yards of woolens by applying the unit of pro- 
duction which produced the silk, to the making of 
woolens. Hence the exchange will not be less than 
5, nor more than 15 yards of silk for 10 yards of 
woolens. 

These, however, are merely the outside limits. It 
may happen that A does not require more than 10 
yards of wool, nor more than 15 yards of silk, 
and B's requirements are similar. In that case, the 



262 AN INTRODUCTION TO ECONOMICS 

exchange will be at the rate of 10 yards of woolens 
for 15 yards of silk. 

So simple an exchange, however, uncomplicated 
by questions of cost of transport and hindrances of 
duties, is seldom secured. Essentially the exchange 
will be decided by the reciprocal demands of the two 
countries. That is to say, the law of supply and 
demand will regulate the rate of exchange. The 
student must remember, in this discussion, w^hat 
was said in Chapter X in regard to the limitation of 
the law of supply and demand. 

The question is further complicated when we con- 
sider the exchange as being between three or more 
countries instead of between two only, and also when 
we add the cost of transportation and the effects of 
protective duties. To give a full discussion of inter- 
national trade treating carefully the questions involved 
in the additional diflSculties suggested, would be beyond 
the scope of this book. One point, however, is worth 
considering, in that it appears to refute the theory 
as outlined in the foregoing paragraphs. According 
to this theory there would be no point in importing 
into and exporting from a country the same goods, 
and yet a glance at the tables of imports and exports 
of many countries will show that this appears to be 
the actual fact. 

As a matter of fact, however, the export and import 
of the same commodity is an appearance rather than 
a reality. The United States both imports and 
exports pig iron. To the layman, pig iron is simply 
pig iron. But to the expert it is a generic name for 
many different substances. The varieties imported 



INTERNATIONAL TRADE 263 

into this country usually have some special qualities 
which the home-produced iron lacks. This is the case 
in regard to the import of spiegel iron and ferro- 
manganese. In the case of the import and export 
of cotton goods, again, the goods are of different grades 
and qualities from those manufactured in this country 
and exported therefrom, and, consequently, they are 
actually different commodities. 

International Price — We have so far argued as 
if the whole of international trade were carried on 
under a system of barter. In a sense, of course, that 
is true, but only in the sense that all exchange is 
merely the exchange of goods and services for goods 
and services, the process being, as it were, lubricated 
by the money and banking system. Our argument, 
therefore, is not vitiated by the fact that money and 
credit instruments are used to a very high degree in 
the process of international exchange. We shall have 
occasion in the next chapter to discuss the method of 
international exchange, and at present the discussion 
must be confined to the question of the comparative 
prices of products in the producing country and in 
the importing country. 

Again it is necessary, for the sake of simplifying the 
argument, to ignore at first the effect of cost of trans- 
portation and of artificial interferences to the process 
of exchange. Leaving these two considerations out 
of account for the present, therefore, and following 
the working of the laws of supply and demand in a 
free market, we arrive naturally at the conclusion 
that there will be an equation of prices. The export 
of the goods merely makes the market wider and the 



264 AN INTRODUCTION TO ECONOMICS 

full and free play of competition will result, as in the 
former market, in the establishment of a market price. 
It must always be remembered, however, that the 
working of the law of supply and demand is limited 
in the manner explained in Chapter X. 

Price is, of course, merely the statement of value 
in terms of money. Consequently there must be an 
equation of the value of money in the exporting and 
importing countries in order that our statement 
of the equation of prices may hold good. Such an 
equation follows, however, from the facts that we 
have presupposed, i.e., a free and open market. In 
the case of countries in which the same commodity 
is used as money, as, for instance, where both countries 
use the gold standard, any increase in the value of 
gold in one country unaccompanied by a similar increase 
in the other will cause a stream of gold to flow towards 
the country where its value is higher and thus, by 
increasing the supply, cause a fall to the same value 
as that in the country from whence the gold was 
exported. 

The Cost of Transport — An essential variation in 
the prices of the two countries is due to the cost of 
transportation. But this increase in the cost due to 
the expense of transporting the goods from one country 
to another may be regarded as a payment for an 
additional service, the services of transport. From 
the price in the importing country, therefore, we may 
deduct that part which is due to freight charges, as 
being payment for the service of transportation — ■ 
an additional utility to that possessed by the goods 
imported. Hence in a theoretical discussion, such 



INTERNATIONAL TRADE 265 

as the present, the truth of the argument is not im- 
paired by any question of increased price due to freight 
charges. 

The question of the influence of tariffs must be 
deferred until a later chapter. 

The Equation of Indebtedness — It will be noticed 
that care has been taken to speak of the exchange of 
goods and services, rather than of goods alone. It is 
frequently, but erroneously thought that international 
trade consists merely in the export and import of 
actual physical materials. This idea has given rise 
to the theory that is known as the " balance of trade." 
This theory has played a very important part in the 
past history of economics and indeed is still frequently 
used in commercial articles. It has always been 
realized that international trade, like all other trade, 
results in an equation of satisfactions, that is, each 
party to the transaction conceives himself as getting 
as good as he gave. Now it is obvious that in inter- 
national trade the amount of actual commodity 
exports seldom equals the amount of actual commodity 
imports. How, then, is the difference made up ? 

It was assumed that the difference, or balance, 
was made up by the import or export of bullion to 
the amount necessary to restore the balance. If a 
country exported a hundred million dollars' worth of 
goods and imported a hundred and twenty million 
dollars' worth, it was assumed that twenty million 
dollars had to be exported in bullion or coin to restore 
the balance. When the theory was formulated, there 
was an erroneous idea that a country's wealth could 
be measured by the amount of gold within that country. 



266 AN INTRODUCTION TO ECONOMICS 

Hence anything which tended to draw gold to the 
country was regarded as being beneficial and anything 
which tended to drive gold away was harmful. In 
case imports exceeded exports, therefore, the country 
was assumed to be in a bad position, for gold must 
go out of the country to make up the difiference. In 
this case, the country was said to have " an adverse 
balance of trade." If, on the other hand, exports 
exceeded imports, the balance was favorable, for then 
gold would flow into the country. 

A study of the imports and exports of bullion, how- 
ever, will show that they bear little relation to the 
exports and imports of other commodities. The 
theory, therefore, fails, for it does not fit the facts. 
As a matter of fact, gold is simply a commodity like 
any other, and obeys the same laws. As far, then, as 
the welfare of the country is concerned, the balance of 
trade is of little importance. It must not be thought, 
of course, that the balance of trade is without signifi- 
cance. There is, indeed, much to be learned from 
the relative amount of imports and exports of goods. 
The old interpretation, however, is proved to have no 
truth. 

This does not answer the question of the actual 
making up of the balance. If gold does not supply 
the difference, how is it supplied "^ There are many 
factors to be considered. In the first place, we must 
note the services rendered by one country to another 
in transport. Before the war a very large portion 
of the carrying trade of the world was performed 
by Great Britain. Britain was always in a condition 
of " adverse balance," and the goods which were 



INTERNATIONAL TRADE 267 

imported over and above the exports in part paid for 
the freight charges which her shipowners levied on 
the carrying of goods. It has been estimated that 
the carrying trade of Great Britain was responsible for 
imports to the extent of nearly $500,000,000 annually. 

Again loans are constantly in process from one 
country to another. Merchants and capitalists of 
one country invest in the securities of another country. 
French capitalists held the great bulk of the Russian 
loans. American securities — railroad bonds, for ex- 
ample, are quoted on all the European exchanges. 
English railroad bonds are held in America. Now 
when an Englishman buys Southern Pacific bonds he 
does not pay in actual money. He pays (in the manner 
which will be detailed in our next chapter) in reality 
by sending goods to America. There is no immediate 
and obvious per contra to this import of British goods, 
but ultimately the loan has to be returned, and each 
year the dividends must be paid, and these return 
payments mean the export of American goods to Great 
Britain. 

Still further, the governments of countries must 
maintain staffs of consuls and ambassadors abroad. 
The payment of these representatives and their expendi- 
ture in the countries in which they reside necessitate 
an export of goods from the country whose govern- 
ment they represent. Tourists, also, making use of 
travelers' checks, are causing a flow of goods from 
their home country. When one country pays an 
indemnity to another, or buys a piece of territory (as 
when this country purchased Alaska) goods are ex- 
ported to furnish the payment. 



268 AN INTRODUCTION TO ECONOMICS 

There are other factors, but we have enumerated 
sufficient to show that the balance is restored by- 
indebtedness which is not obvious in the trade returns. 
These purchases of securities, lending of shipping 
services, payments of consuls, and so on, may be 
regarded as invisible exports and imports, as contrasted 
with the visible imports and exports of goods. The 
visible and invisible exports of a country, which repre- 
sent its indebtedness to other countries, are balanced 
by the visible and invisible imports of the country, 
which represent the indebtedness of other countries 
to the first. Instead of a balance of trade, therefore, 
what we have is an equation of indebtedness, which 
is a totally different thing. 

The whole question is obscured by the apparent 
lack of connection between the lenders who purchase 
securities, and the exporter of the goods which really 
pay for the securities. This matter will be made 
clearer in our next chapter. 



CHAPTER XXI 

DOMESTIC AND FOREIGN EXCHANGE 

Difficulties in Paying by Check — The purpose 
of this chapter is to discuss the mechanism of payments 
made over a long distance. In a small country like 
Great Britain, for instance, payments within the 
country can, as a rule, be readily made by means of 
the check of the payer. If a merchant in London 
desires to pay for goods bought from a Glasgow firm, 
all he has to do is to send his check for the amount. 
The Glasgow merchant will then deposit the check 
in his bank for collection. 

This method is possible also in America, but it is not 
so satisfactory. The country is so large that there 
is necessarily a considerable period of waiting to be 
done before a check drawn on, let us say a Los Angeles 
bank, can be paid in New York. The New York 
bank does not know the drawer of the check and 
consequently will not pay the amount called for on 
presentation of the check. He will send it first to 
his Los Angeles correspondent for collection. This 
takes time, and the merchant to whom the payment 
is due hardly cares to wait until collection. He wants 
his money at once. The Los Angeles merchant, there- 
fore, must provide some other means of payment. 
This illustrates the difficulty of making payments 
over a long distance. Domestic exchange, as the 

269 



270 AN INTRODUCTION TO ECONOMICS 

actual system is called, is similar in all essentials 
to foreign exchange. The only important difference 
that exists between the two is due to the fact that, 
as a rule, there are different currency systems in dif- 
ferent countries. This complicates the question, with- 
out altering the fundamentals. Let us first consider 
the question of domestic exchange. 

Gold or Currency Payments — There is always 
the possibility of sending actual currency in payment 
of debts. Our Los Angeles merchant, for example, 
might send to New York the necessary amount in 
gold or currency. This necessitates a certain expense, 
however, for one cannot ship currency without pay- 
ing for transportation charges. In reality there are 
three items in the expense of a currency shipment. 
First there is the actual expense of transportation — 
the freight, as it were ; second, there is the cost of 
insuring the money ; finally there is the loss of interest 
on the currency during its transport. For example, 
if a shipment of $10,000 is made from Los Angeles 
to New York, it will take about five days to reach 
its destination. That means that the merchant who 
has made the shipment will have to remove the cur- 
rency from the bank, or other place where it is earning 
interest, five days before he would have to do so, if 
the payment were to be made in his own city. There- 
fore he loses that five days' interest, and consequently 
the amount of the loss must be charged to the cost of 
the shipment. 

If gold is used, there will be a drain of gold to the 
extent of that payment from the transmitting city. 
Naturally, however, the shipments are not all in the 



[ 



DOMESTIC AND FOREIGN EXCHANGE 271 

same direction, or else the city which sends out the 
gold would soon have none left. Payments are not 
only made by the merchants of a city, but to them as 
well. Hence there will be a certain amount of cross 
shipping, gold and currency leaving the city and gold 
and currency entering it. 

As we have already seen in our discussion of the 
checking system, this involves a great waste of cur- 
rency. The currency is idle while in transport. Not 
only is it not being used for payments during the 
interval, but it cannot be used as a basis for credit 
money to be issued. From every point of view, there- 
fore, such a method is wasteful. 

Payment by Draft — The difficulty is very largely 
solved by means of the banking system. Each com- 
munity has some cientral town or city which has rela- 
tions with all parts of that community. In California, 
for instance, every town has direct commercial rela- 
tions with San Francisco. Every bank will have 
business dealings with the banks in the central city 
of the community. In a similar way, every town of 
any importance in the country has definite business 
relations with New York, which is the money center 
for the whole country. The relation between the 
banks of one city and another is known as the relation 
between correspondent and agent. If the First Na- 
tional Bank of San Francisco deals directly with the 
National City Bank of New York, it regards the latter 
as its correspondent. If the New York bank sends 
its checks drawn on San Francisco to the First National 
for collection, then the First National is the agent 
of the National City Bank. 



272 AN INTRODUCTION TO ECONOMICS 

The First National, in order to use the National 
City Bank as its correspondent, deposits funds with 
the New York bank in the same way in which a private 
firm deposits its funds in the local bank. Let us 
suppose, now, that the First National of San Francisco 
has on deposit with the. National City Bank the sum 
of $100,000. If a merchant in the Pacific city wishes 
to make a payment in New York, he has three choices 
open to him. He may ship currency, he may draw 
a check on his bank anchsend it in payment, or he may 
buy exchange. The la^Ser is the usual method. To 
do this, he goes to the First National and asks for a 
" draft " on New York, for a certain sum. He pays 
for this draft and the banker hands him what is, to 
all intents and purposes, a check drawn upon the 
National City Bank. When that check or draft 
arrives in New York, the bank there charges it against 
the deposit credit of the San Francisco bank and pays 
the check just as it would pay a check drawn on a 
neighboring bank or upon itself. 

The banker does not sell this draft out of pure 
kindness of heart ; he makes a charge for his services. 
There is a limit to the amount he can charge, however. 
The cost of shipping currency from the Pacific Coast 
to New York is about $1.50 per $1000. The actual 
cost will vary, of course, according to the rate of 
interest. If the bank charges more than that amount 
for its draft, it will pay the merchant to ship currency. 
Hence, if the bank wishes to do business at all, it 
must keep its charges for exchange below the cost 
of shipping currency. The point at which it pays 
to ship currency is commonly called the " gold point." 



I 



DOMESTIC AND FOREIGN EXCHANGE 273 

These transactions are not all one way. Just as 
there are payments to be made in New York, so there 
are payments to be made by New York. The National 
City Bank, for instance, may have drafts drawn on 
San Francisco sent to it to be collected. These drafts 
it forwards to the First National for collection and 
immediately sells its own drafts on San Francisco 
to be paid for by the money collected in the San 
Francisco institution. 

This is simple enough, of course, if we deal only with 
the two cities. But all payments are not made to or 
by New York. What happens when a payment has to 
be made, let us say between Peoria, Illinois, and Seattle, 
Washington ? It is not to be supposed that the 
Peoria bank carries deposits in the Seattle bank, or 
vice versa. Suppose a Seattle merchant wishes to 
make a payment in Peoria. He asks his bank for a 
draft. The Seattle bank, thereupon, sells him a 
draft, not on Peoria, but on New York. New York 
exchange is always acceptable, owing to the vast 
number of transactions with that city. The Peoria 
bank is perfectly willing to cash the draft, for it 
knows that it can deposit the draft with its own New 
York correspondent and sell New York exchange itself. 

This method of settling payments over a distance 
is one of the commonest. There is another method, 
by use of the discount system, with which we shall 
deal fully in considering foreign exchange. Before 
we do so, however, we must deal with the question 
of the relations between different coinages. 

Mint Par of Exchange — In order to simplify the 
discussion, we shall consider only two coinages, for 



274 AN INTRODUCTION TO ECONOMICS 

the principles involved are the same no matter how 
many we examine. There are minor difficulties, of 
com*se, but these can only be dealt with in a much 
fuller treatment than is possible here. The British 
currency is, like the American, on a gold basis. The 
sovereign consists of a certain weight of gold. So 
does the dollar. If an English sovereign were to be 
recoined into American money, the coin would be of 
the value of $4.8665. That is to say, there is as much 
pure gold in an English sovereign as there is in an Amer- 
ican coin (if one were actually coined) worth four dol- 
lars and eighty-six and two thirds cents. The equiva- 
lent is known as the Mint Par of Exchange, or simply, 
the mint par. It is around this figure that the price 
of the English sovereign, in terms of dollars and cents, 
will fluctuate. 

If, for instance, an American merchant owes £1000 
payable in London and wishes to make payment in 
gold, he must send gold to the value of $4866.50 to 
England. But that amount of gold, sent to England, 
will cost him more than the $4866.50. There will be 
the expense of assaying the gold to determine its 
purity. There will also be the cost of packing and 
freight. The shipment will have to be insured, and 
while on the voyage no interest will be earned. The 
gold will be out of his hands from seven to ten days 
and consequently the shipper will not be able to loan 
the money for that period, or he must take the cash 
from some investment seven or ten days earlier than 
would be necessary if the debt were to be paid at 
home. 

If he can buy a draft on London, in the same way 



DOMESTIC AND FOREIGN EXCHANGE 275 

as he would a draft on New York, and the cost of 
buying such a draft is less than the cost of packing, 
shipping, insuring, etc., the shipment of gold, he will 
buy the draft. 

The same is true in the case of a debt due by an 
Englishman to an American merchant. If the cost 
of the draft is higher than the cost of gold shipment, 
the gold will be sent. Otherwise the draft will be 
used. The cost of sending gold, therefore, limits 
the amount which may be charged for drafts. If 
we say that the cost of shipping gold amounts to two 
cents per sovereign, then gold will be shipped from 
America when the charge for drafts is greater than 
$4.8865. Gold will be imported when the price of 
the sovereign goes down below $4.8465. 

The two points at which gold is shipped are known 
as the gold points. The principle upon which the 
theory of the gold movements is based is very simple. 
The merchant who is desirous of making a payment 
wants to make that payment as easily as possible. 
He has a debt of a certain amount to pay, and it 
costs him something to make the payment. He 
naturally, therefore, chooses the method of making 
the payment which will cost him the least. 

In actual practice, however, there are difficulties 
which take away a good deal of the simplicity of the 
process. For example, the gold points do not always 
work out as easily as we have suggested. There is 
still a strong belief in many countries that gold possesses 
peculiar properties. It is regarded as a kind of insignia 
of wealth. There is, therefore, a great reluctance to 
permitting any gold to leave the country. Difficulties 



276 AN INTRODUCTION TO ECONOMICS 

are placed in the way of the exporter which increase 
his expenses. In some cases, for instance, a premium 
is charged for purchasing gold for export. This at 
once raises the gold point beyond the height reached 
by adding the cost of transportation, interest, etc., 
to the value of the gold. Governments occasionally 
prohibit the export of gold and hence gold shipments 
become impossible. Again, in the United States 
gold is not the only lawful money, as it is in England 
(with the exception of some wartime currency). 
Hence the merchant cannot always depend upon 
getting gold without considerable difficulty, all of 
which is expensive. Before the war Great Britain 
was practically the only country in the world in which 
gold could be obtained without any restriction. Theo- 
retically no change has been made in regard to Great 
Britain's position ; there is no law or regulation for- 
bidding the export of gold. As a matter of fact, how- 
ever, those in authority in the treasury in London 
have not looked favorably on any suggestion to export 
gold. Bankers have been unwilling to offend the 
treasury, for obvious reasons, and hence the same 
result is effected as if there were definite obstacles 
placed by government against export. 

Method of Paying for Foreign Goods — So far, 
we have dealt with the principles merely. We shall 
now turn to the actual practice, in order to obtain 
a clear idea of the causes of fluctuation in the rates 
at which foreign money is bought and sold. 

Let us consider the case of an American merchant 
who has bought some Chinese silk. He desires to 
have that silk and dispose of it on the market before 



DOMESTIC AND FOREIGN EXCHANGE 277 

lie makes payment to the Chinese merchant from 
whom he bought it. The Chinese merchant may be 
wilHng to offer him, say, sixty days' credit. How is 
he to ipsij? The payment cannot be made in the 
simple fashion of buying a draft on a Chinese bank 
from an American bank. As a rule American banks 
do not maintain deposits with banks in China. The 
method is a little more complicated. Just as in domes- 
tic exchange every one is willing to take drafts on New 
York, so in foreign exchange, drafts on London are 
always desired. 

At the outset of his dealings with the Chinese mer- 
chant, the American will have to establish his credit 
before he can obtain goods. The Chinese merchant 
as a rule will aisk to receive what payment is due by 
bills on London. The American therefore arranges 
to pay him in this way. He approaches his own banker 
and describes the nature of the transaction upon 
which he is about to engage. If the banker is satisfied, 
he agrees to open a credit for the merchant for the 
necessary amount, which, we may say, is for $10,000. 
Put into English money, this will amount to (roughly) 
£2000. The banker instructs his correspondent in 
London (that is a bank in London with whom he is 
in the habit of doing business and maintaining deposits) 
to open a credit to the extent of £2000 in favor of the 
Chinese merchant. The Chinese merchant will, in 
due course, receive from the London correspondent 
a letter somewhat like the following : 



278 AN INTRODUCTION TO ECONOMICS 

London, January 1, 1919. 
Messrs. Lee Wong & Co., 
Shanghai, China. 

Dear Sirs, 

We hereby beg to confirm to you Credit No. 65 opened 
with us in your favor by Messrs. John Robinson & Company, 
of New York for £2000 (say two thousand pounds sterUng) 
for which amount we shall duly honor your drafts at sixty 
days' sight drawn in Shanghai. This credit expires unless 
previously canceled on January 1, 1920. 

All drafts against this credit must be drawn and duly 
advised to us before that date, and must be accompanied by 

Consular Invoice. 
Bills of Lading. 
Insurance Certificate. 

Please insert in your drafts the number and date of the 
credit and the initials of the firm by whom you are accredited. 
A copy of the advice to be attached to each draft drawn under 
this credit. 

Yours truly, 

The London City and Midland Bank. 
£2000. o. o. No. 5432. 

There are some items mentioned in this letter which 
require explanation. The value of the goods imported 
into a foreign country is usually certified to the consul 
of that country at the place of entry. The consul 
then signs an invoice showing the amount. This is 
known as the consular invoice. It frequently happens 
that before goods imported from a foreign country 
can be received by the importer from the ship the 
importer must show to the customs authorities the 



DOMESTIC AND FOREIGN EXCHANGE 279 

consular invoice of the goods. The consular invoice, 
therefore, is one of the documents necessary to . the 
importer. Again, when the goods are shipped, the 
shipper receives from the transportation company 
what is practically a receipt for the goods. This 
receipt is known as a bill of lading. The importer 
of the goods must show to the agents of the steamship 
some authority for his statement that the goods belong 
to him. Naturally a steamship company will not 
hand goods to any one who claims possession. The 
documents which the steamship company recognizes 
as constituting title to the goods are the bills of lad- 
ing. In case of loss of the goods, the value can only 
be recovered from the insurance company by the 
person who possesses the policy or certificate of insur- 
ance. Hence this certificate, also, forms one of the 
necessary documents. In order, therefore, for the 
importer to obtain his goods, he must be able to show 
title by presenting these evidences that the goods are 
intended for him. 

Now let us turn to the position of the Chinese mer- 
chant. He receives the letter of credit in due course 
and has the goods ready for shipment. Before shipping, 
he obtains from the United States consul in Shanghai 
a consular invoice for the goods. This he makes out 
himself and certifies, the consul signing the certificate. 
Then he sends the goods to the steamer and receives 
the bills of lading. At the same time he insures the 
goods with some marine insurance company or broker 
and obtains the policy. 

When he has these necessary documents, he draws 
a draft somewhat as follows : 



280 AN INTRODUCTION TO ECONOMICS 

January 21, 1919 
To the London City and Midland Bank, London 

Pay to my order sixty days after sight, the sum of two 
thousand pounds sterhng (£2000. o. o.). Second and third 
of same tenor and date unpaid. 

£2000. o. o. 65. J. R. & Co. Lee Wong & Co. 

To this draft he attaches the three documents 
already mentioned. The draft is now known as a 
documented draft. Lee Wong and Company, how- 
ever, do not wish to wait for sixty days before receiving 
payment. Neither do they wish for the actual cur- 
rency in English money. They take the documented 
draft to their own bank in Shanghai together with 
the letter of credit. This letter is evidence to the 
bank that the company has been authorized to draw 
upon the London bank. The Shanghai bank dis- 
counts the draft, giving the equivalent of the face 
value, less the deducted interest or discount, to Lee 
Wong and Company, in Chinese currency. Lee Wong 
and Company are now out of the transaction. They 
have received payment for their goods and are satisfied. 
But Robinson and Company, of New York, have not 
paid yet, so we must follow the draft a little further. 

The Shanghai bank forwards the draft, with its 
attached documents, to its London correspondent, 
which is, let us say, Parr's Bank. Parr's Bank, when 
they receive the documented draft, forward both to 
the London City and Midland Bank for " acceptance." 
The latter writes across the face of the draft the words 
" Accepted, February 25, 1919," and signs the draft. 
The bank official detaches the documents and returns 



DOMESTIC AND FOREIGN EXCHANGE 281 

the draft (which is now called an acceptance) , hands the 
draft to the representative of Parr's Bank and forwards 
the documents to the New York bank which had 
opened the credit on behalf of Robinson and Com- 
pany. The latter hands the documents to Robinson, 
so that he can obtain the goods. 

Meanwhile, Parr's Bank will obtain actual cash for 
the acceptance by selling it in the discount market, that 
is, selling it to one of those firms whose business it is 
to invest money for short periods by purchasing such 
drafts. 

The money obtained by the sale of the acceptance 
is placed to the credit of the Shanghai, bank, which 
is now able to sell drafts on London to Chinese mer- 
chants who have payments to make in English money. 

We have now reached the point where the Chinese 
merchant has received his money and Robinson and 
Company have received the documents entitling them 
to the possession of the shipment of silk. The latter 
obtain the goods and sell them in the American market. 
Meanwhile the sixty-day period mentioned in the draft 
is drawing to a close. , Before the time is up, Robinsons 
will have sold the bulk of the goods. They pay the 
New York bank which opened the credit for them. 
The bank thereupon forwards the necessary amount 
to the London City and Midland Bank in time to 
reach that bank on or before the date of maturity of 
the draft. On the day of maturity, that is, sixty days 
after the word accepted was written across the draft, the 
holder of the draft presents it to the London City 
and Midland Bank for payment. The latter, having 
received funds from New York, pays the draft and the 



282 



AN INTRODUCTION TO ECONOMICS 



whole transaction is finished. Only one thing remains 
to be said : How does the New York bank send the 
amount to London ? 

The probability is that the New York bank has 
bought drafts on London from American merchants 
who have English debts due to them, and sends these 
drafts to the London City and Midland Bank, The 
latter can then cash the drafts and from the proceeds 
pay the debt due on the acceptance based on the silk 
transaction. 

The accompanying diagram, Fig. 7, will help to 
explain the method which has just been described. 




FIG. 7 



DIAGRAM ILLUSTRATING METHOD OP PAYMENT 
FOR AMERICAN PUR C HAS£ OF FORE IG N GOODS. 



The reverse transaction, the payment by a foreigner 
for goods bought from an American, may be made 
in the same manner. There is, however, a simpler 
method which is coming into practice. Suppose 
a Stocldiolm merchant desires to pay for goods bought 
in America. He arranges with his Stockholm bank 
to open a credit for him in New York. This the latter 



DOMESTIC AND FOREIGN EXCHANGE 283 

does by buying drafts on New York or in various 
other ways with which we cannot deal. The merchant 
now has what amounts to a deposit credit in New 
York. He draws his drafts or checks against this 
credit and forwards them direct to his New York 
creditor. The latter deposits the checks in his own 
bank and the transaction is settled. 

It should now be clear to the student that there is 
a great deal of purchase and sale of debts due in foreign 
countries. The banks which deal in foreign exchange 
constantly purchase from merchants the drafts which 
they have drawn upon their foreign debtors. These 
are sent to correspondent banks in the foreign countries 
and then drafts are sold to Americans. There is a 
definite charge made for each transaction, hovv^ever. 
Assuming that all bills are of the same length of time, 
the charge will to a large extent be governed by the 
amount of " commercial bills, " as the drafts we have 
been discussing are called, that happen to be in the 
market. If a banker finds it difficult to obtain bills 
drawn on London, for instance, he raises his price 
to the seller. But as he has to pay a higher rate for 
the drafts he purchases, he must charge a higher 
rate for the drafts he sells. The smaller the number 
of commercial bills in the market, the higher will be 
their price, or, in other words, the lower will be the 
rate of discount, and the higher will be the price of 
drafts sold by the bank. That is, if an American 
bank finds that it has to pay a high price for drafts 
on London, when selling drafts against the deposit 
credit he has built up in London, he will ask more 
dollars and cents a pound sterling. 



284 AN INTRODUCTION TO ECONOMICS 

Finance Bills — The bankers are not entirely de- 
pendent upon commercial bills, however. There are 
ways of manufacturing bills which have nothing to 
do with commercial transactions. Suppose that the 
number of drafts drawn upon London, and based 
upon commercial transactions which involved sales 
of goods to English or other foreign merchants, happens 
to be small. And suppose that, at the same time, 
the demands for London exchange (or sterling exchange, 
as it is called) are large. Where are the bankers to 
find the means of adding to their deposits in London 
so that they may sell sterling exchange .? They arrange 
to borrow from the London banks and to have the loans 
placed to their credit in those banks. They then sell 
drafts against the new deposits, relying upon being 
able either to buy commercial bills to repay the bank 
in London, or else to renew the loan at maturity. 
Such bills, based upon loans made by the London 
banks, are termed finance bills, and they are of great 
value in keeping the rate of exchange steady, or at 
least in preventing undue fluctuation. 

Effect of the Time Element on the Price of Exchange 
— All bills are not of the same length of maturity. 
Some are drawn at sight, some at thirty days, some 
at sixty, and so forth. Some drafts are sold on the 
understanding that the amount to be paid in the 
foreign country shall be telegraphed to the paying 
bank so that the transfer of the money shall be practi- 
cally immediate. These latter are known as telegraph 
or cable transfers. Now obviously, when there is a 
period of time to elapse before the actual payment 
is made, the question of the rate of interest becomes 



DOMESTIC AND FOREIGN EXCHANGE 285 

important. The possession of a draft on a bank carries 
the title to money. But we have already seen that 
there is a different marginal utility in regard to present 
and future goods. Hence, a man who has a draft for 
$1000 will think himself better off if the draft calls 
for immediate payment than if it calls for payment 
in sixty days. He will, therefore, be willing to pay 
more for money immediately available than for money 
at some future date. The rate for cable transfers 
is, as a consequence, higher than for sight drafts, 
which, in the case of American bills drawn on London, 
means a delay of about ten days before payment can 
be made. Sight drafts will be higher than thirty 
or sixty-day paper, and so on. 

The rate of exchange between two countries, then, is 
not a single rate, but varies according to the length 
of the maturity of the drafts. In any table of exchange 
rates it will be seen that a series of rates is given for 
each country mentioned in the list. 

Effects of the Rate of Interest upon Exchange Rates 
— Ignoring differences in the length of time at which 
the drafts mature, there remains to be considered 
the effect of changes in the rate of interest upon the 
exchange rate. If interest rates in London are high, 
American foreign exchange bankers will be anxious 
to take advantage of those high rates and to increase 
their deposits in London. To do this, they must 
buy drafts that are drawn on London. The increased 
demands for those drafts raises their price. A high 
rate of interest in London means a high price for 
commercial bills drawn on London. As soon, how- 
ever, as the increased deposits in London have reached 



286 AN INTRODUCTION TO ECONOMICS 

the point at which the supply of loanable funds or 
credit in London is great enough to cause a fall in 
interest rates, the demand for bills drawn on London 
will decrease, and hence the price for them will fall. 

The Causes of Gold Movements — We have seen 
above that the increase in the interest rates abroad 
causes a rise in price of commercial bills drawn on 
the foreign countries. As the reason for this increase 
is the desire of the bankers to increase their interest- 
earning funds abroad, where the high rate obtains, 
they will only sell exchange on the foreign countries 
(that is, sell drafts drawn upon their foreign deposits) 
at a higher rate. If that rate should go beyond the 
gold point, there will be shipments of gold. A certain 
class of banker watches these interest rates very 
closely. As soon as it becomes profitable for him to 
ship gold to the foreign country (or to import gold from 
abroad) he does so. The actual percentage of profit 
made on these transactions in gold is very small, but 
the large amounts of gold actually shipped make 
the actual amount of profit sufficient to justify a 
very considerable business. Such a business is known 
as arbitrage. 

Again, it must be remembered that America is 
a gold-producing country and gold takes its place 
with ordinary merchandise. The balance of trade, 
therefore, has nothing whatever to do with gold ship- 
ments, and while the phrase is not without value 
in the estimation of the trade conditions of a country, 
its value is very different from that attached to it by 
the mercantilist philosophers who originated the 
phrase. 



CHAPTER XXII 
PROTECTION AND FREE TRADE ' 

Definitions of Protective and Revenue Taxation — 

In our discussion of the theory of international trade 
we considered the question from the point of view 
of free competition. This was necessary in order 
to clear the ground for the further discussion including 
those factors which tend to modify conclusions drawn 
from such a standpoint, or, in other words, the dis- 
cussion of the limitations of competition between na- 
tions caused by the presence of hindrances not due 
to natural causes. 

We shall, in the present chapter, consider some of 
the problems caused by the imposition of protective 
duties, but before we do so we must understand exactly 
what is meant by protective duties. Some of the factors 
dealt with in the present discussion are also included 
in the study of public finance — a study which will be 
touched upon in a future chapter, but it is sufficient, 
for the present, if we understand that in the financial 
arrangements of a country other questions are con- 
sidered besides the mere collection and expenditure 
of revenue. Provisionally we may say that taxes 
may be divided into two parts, the first including 
those which are imposed entirely for the purpose of 
providing funds to carry on the administration of 
government, and the second containing those which 

287 



288 AN INTRODUCTION TO ECONOMICS 

have for their aim the regulation or stimulation of 
industry, and whose revenue-collecting functions are 
incidental. 

To the first class we assign the term revenue duties, 
and to the second, 'protective duties. In both classes 
we are restricting ourselves to the consideration of 
indirect taxes; that is, taxes whose incidence maybe 
shifted several times before the final tax bearer is 
reached. Our meaning may be made clearer by an 
illustration. A tax on tea is usually paid by the 
importer, but he adds the amount of the tax to the 
price he charges to the jobber. The latter again 
includes it in his price to the retail dealer, who trans- 
fers it to the consumer. On the other hand, a tax 
on income is usually paid by the person upon whom 
it is levied, i.e., the person in receipt of the income. 
The latter tax is direct and the former indirect. 

All indirect taxes are not protective, however. 
To be protective the tax must not fall on all the goods 
which form its subject. For revenue purposes the 
tax should fall without distinction on goods produced 
within the country and similar goods imported from 
other countries. The protective tax falls only upon 
those goods which are of foreign origin. Taxes on 
liquor, which are levied on imported as well as home- 
made liquor, are obviously instituted for the purpose 
of gaining revenue. On the other hand, taxes which 
are imposed upon imported steel goods, but not on 
steel goods manufactured within the country, are 
protective duties. There is a definite distinction be- 
tween the foreign and the home product, and the ob- 
ject of the imposition of the tax is not primarily the 



PROTECTION AND FREE TRADE 289 

obtaining of revenues, but the elimination of foreign 
competition from the steel manufacturing business 
within the country. 

It should be obvious that a revenue tax does not 
interfere with international trade as far as freedom 
of competition is concerned, whereas the protective 
tax is designed to produce such interference, in order 
to handicap the foreign producer and prevent him 
from obtaining the fruits of his comparative advantage 
in production. 

Effect on Prices — If a protective duty is to be 
of value to an industry it is essential that it should 
mean a rise in price of the protected articles. If, 
under free competition, a price is reached, we know 
that such a price is the result of the interplay of the 
laws of supply and demand. The price of foreign 
goods introduced into a country cannot be greater 
than that of those produced within the country, for 
if it were the foreign goods would not be sold and 
they would soon cease to be imported. On the other 
hand the price of the home-produced goods cannot 
exceed that of the foreign goods, for if so, the home 
production would not be sold. Hence the objection 
to the free importation of foreign goods is due to the 
supposition that the price resulting from free compe- 
tition is too low to be satisfactory to the home pro- 
ducer. 

If, therefore, the protection extended by the imposi- 
tion of duties upon imported foreign goods does not 
enable the home producer to raise his price, from his 
point of view there is no good result. For instance, 
if the price for a certain commodity is fixed under a 



290 AN INTRODUCTION TO ECONOMICS 

system of free competition, at $5 a ton, the demand 
for protection against foreign imports of this commodity 
must be due to tJie belief that $5 a ton is too low 
to be sufficiently remunerative to the home producer. 
If, then, a protective duty of $1 a ton is imposed 
on imports, and the price to the consumer is still $5 
a ton, wherein does the home manufacturer profit? 
He is no better off than before. Obviously, therefore, 
the purpose of the duty is to enable the home producer 
to charge a higher price for his goods. 

It would seem from the above argument that the 
imposition of a duty which was so high that it pre- 
vented any importation of the taxed commodity, 
would raise the price of the home product by exactly 
the amount of the duty, any further rise, of course, 
making it again worth while for the foreigner to enter 
the market. This is not necessarily the case, how^ever. 
We may distinguish three cases. The first is that 
in which the duty has no effect whatever. If we con- 
sider the case of a commodity which is produced as 
cheaply at home as abroad (allowing for the cost of 
transportation of the foreign goods) and in sufficient 
quantities to satisfy the home market, there will be 
no reason for the importation of that commodity. 
The price will be decided entirely by the conditions 
of the home market. Any duty imposed on importa- 
tion, therefore, will have no effect whatever on the 
price. This case is not so impossible as it might 
appear. American duties have been demanded and 
secured against the importation of foreign w^heat 
and meat products. But as these goods have been 
produced in ample quantities for the home market 



PROTECTION AND FREE TRADE 291 

and just as cheaply as abroad, the imposition of the 
duties has been without effect upon prices. 

The second case is that in which the imposition of 
the duty has not succeeded in preventing importation 
of the foreign product. In this case, the consumer 
necessarily pays the foreign price plus the exact amount 
of the duty for any foreign product he may buy. 
That is to say, the difference between the price of the 
home product and the net price received by the for- 
eigner is exactly the amount of the duty. This does 
not necessarily mean that the price to the consumer 
has been increased by the amount of the duty. It 
may be that the cost of production of the foreign 
commodity is such that the producer can reduce his 
price and still make an adequate profit. To illustrate 
this let us return to the case of the commodity sold 
at $5 a ton before the imposition of the duty. If 
a specific duty of $1 a ton is imposed upon importa- 
tions, and the foreigner cannot reduce his own price, 
the new price to the consumer will be $6 a ton. The 
foreign goods which are actually imported will pay 
$1 a ton to the government. But suppose that 
the foreigner can sell at $4.50 a ton and still make 
a satisfactory profit? In that case he may reduce 
his net price to $4.50 and send in the goods. The 
price to the consumer will, therefore, be $5.50 and 
the home producer cannot exceed that price. Hence, 
while the difference between the net price of the 
foreigner and the price charged by the home manu- 
facturer still amounts exactly to the $1 of duty im- 
posed, the actual increase in price to the consumer is 
only 50 cents. 



292 AN INTRODUCTION TO ECONOMICS 

The third case to be considered is that in which the 
importations are absolutely prohibited. Here the 
probability is that the consumer pays an additional 
price amounting practically to the whole of the duty. 

There are various considerations which affect the 
question of the continuance of exports after an import 
duty has been charged. Matters of freight, for 
instance, may have considerable importance. It some- 
times happens that the freight charged on commodities 
imported from a foreign country is considerably less 
than the amount charged for transportation within 
the country. Water carriage is invariably cheaper 
than rail, and sometimes special considerations allow 
of a great reduction even in water carriage rates. 
When Great Britain imports cotton from Galveston, 
the steamers are often glad to get a return freight even 
at very low rates in order to prevent the necessity of 
having to return in ballast. Hence a rate for steel 
rails to Galveston may be less than the cost of carriage, 
and, therefore, considerably less than the cost of rail 
carriage from the North. This difference in cost 
will amount, in effect, to a comparative advantage 
in production and hence may prevent the rise in 
price of the commodity up to the full amount of the 
duty. 

Protection of Young Industries — The greatest 
strength of the arguments in favor of the retention 
or development of the protective system lies in the 
appeal for the protection of young industries. But 
before we can discuss this we must analyze the reasons 
upon which the demand is based. 

In the first place it may be claimed that there is a 



PROTECTION AND FREE TRADE 293 

comparative advantage in the production of a certain 
commodity, when the manufacture or production is 
at maturity, but that in the early stages of production 
the industry could not compete with the already ma- 
tured foreign competitor. Hence it is claimed that 
if this industry is protected in its early growth it will 
have a chance to develop into a strong position and 
ultimately hold its own on even terms with the foreign 
industry, and even to defeat such competition in 
foreign markets. 

In the second place, it may be admitted at the 
outset that the question of comparative advantage 
does not arise at all ; that the industry under con- 
sideration does not and cannot possess a comparative 
advantage. The basis of the argument for protection, 
however, does not lie so much in economic considera- 
tions as in political. It is believed that, in order to 
be prepared for emergencies, such as war, for instance, 
a country should be as nearly as possible self-support- 
ing, and particularly so in the case of production of 
means of warfare. It is obvious, in this case, that the 
argument based on the possibility or otherwise of 
producing at a comparative advantage is beside the 
point. The main idea is based on the possibility of 
production at all, no matter at what cost. 

A further argument affecting the question of pro- 
tecting industries is the " foreign cheap labor " 
argument. It is claimed that, as the average rate 
of wages in America is higher than in the older coun- 
tries, the industry which is just commencing and 
even the mature industry is at a disadvantage in that 
its wages cost is so much higher than abroad. 



294 AN INTRODUCTION TO ECONOMICS 

These three arguments are the chief support of the 
protectionist case for the protection of industry. We 
shall now consider them carefully and attempt to de- 
termine the extent of their validity. 

The first case divides itself into two main sections. 
^ First, the case of young industries commencing in a 
young country, and second, the case of young indus- 
tries in a country already well established in pro- 
duction. The first case is well illustrated by countries 
such as the United States in its early days, and by 
the more important of the British colonies. 

In those industries in which the initial cost of estab- 
lishment is small, the question of long establishment 
is not important. If fixed capital bears a small ratio 
to the total capital involved and if the labor facilities 
are ample, there is no reason for protection. The 
industries will commence at the outset in as good 
a position as those of established foreign countries. 
This is provided, of course, that the comparative 
advantage of production, if any, is in favor of the 
new country. Of course, the case is different if the 
comparative advantage lies with the old country. 
But in this case, the question of protection comes 
under the discussion of our second main heading, and 
so may be ignored here. 

In other cases, where the initial cost of establish- 
ment is heavy, and where the labor skill has to be 
gradually acquired, there is a very much stronger 
case for protection. In the establishment of any 
industry which requires a heavy expenditure for 
fixed capital there is usually a considerable lapse of 
time before returns for that expenditure are received. 



PROTECTION AND FREE TRADE 295 

This is true, even where the labor skill is already exist- 
ent and available. A manufacturer who starts such 
an industry, in the face of efficient competition, is 
at a disadvantage. This is so, even if he has not to 
consider competition from other firms who are already 
well established. 

The object of protection is to eliminate competition 
and so permit the manufacturer to commence work 
with only the ordinary disadvantage of having to 
wait a certain time for returns on his investment. 
Even this is sometimes made more easy for him by 
the offer of bounties on the export or production of 
the new goods. This, of course, is merely another 
form of protection. It is assumed, however, by the 
very nature of the claim itself, that when the industry 
is mature and well established, the initial difficulties 
will be overcome — the infant industry will have 
gained its majority and will no longer require pro- 
tection. Indeed the industry ought to be able to 
produce at a cheaper rate than that charged for the 
foreign goods and thus reimburse the country for the 
original expenditure in protecting its young growth. 

In this case it is necessary to assume that the indus- 
try only requires temporary protection. The object 
of the protection is to permit the industry to be estab- 
lished on a sound footing and then let it take its own 
place in the competitive system. The question then 
arises : When is it clear that the industry no longer 
needs the protection .f^ In other words, when does an 
industry reach maturity.? Herein lies the objection 
urged even against such protection as we have outlined. 
Industries which orginally demanded protection on 



296 AN INTRODUCTION TO ECONOMICS 

account of their infancy insist on the retention of 
the protective duties when they have reached a lusty 
maturity. When it is clear that an industry can obtain 
its product at a cost as low as that of foreign countries 
and can, therefore, compete on satisfactory terms with 
any foreign goods that may be imported, it has 
obviously reached maturity. If the industry goes on 
from decade to decade and still the cost of produc- 
tion is greater than that of foreign countries, it is 
clear that the comparative advantage lies with the 
latter, and hence the justification of the continuance 
of protective duties lies outside the consideration of 
our present argument. It is not sufficient that the 
industry should show merely a reduction in the cost 
of production and a consequent reduction in price 
to consumers. For it may be that a similar reduction 
can be shown in regard to foreign-produced goods. 
The reduction must eventually be down to that of 
the foreign goods. If this equality in cost of produc- 
tion is never reached, then the continuance of pro- 
tection constitutes a tax on the consumers which 
may or may not be justified by other considerations. 
At any rate it no longer rests upon the necessity of 
protecting a young industry. 

Even admitting the validity of the argument, there- 
fore, the difficulty of ceasing to protect an industry 
when it has reached maturity constitutes an argument 
against such protection. It must be understood, of 
course, that a sudden cessation of protection may be 
extremely unwise, but even the ardent free-trader 
seldom demands that an industry which has been 
protected for many years should, at a single stroke. 



PROTECTION AND FREE TRADE 297 

be deprived of all protection. But in actual practice, 
every suggestion for a diminution of the duties is 
bitterly fought, the grounds in favor of the retention 
of the duties being changed to suit the new circum- 
stances. Even in the same breath that the manu- 
facturer boasts of the superiority of his goods to those 
of the foreigner, he declares that, without protection, 
his industry must fail. 

From being asked as an encouragement to commence 
a new industry, protection comes to be demanded as 
a right, and is regarded as a permanent institution. 
It is because of this tendency for the protection to 
be afforded long after the original necessity has ceased, 
that the free-trader regards even " young industry " 
protection as poor policy. 

The same arguments apply equally to protection of 
new industries in a country already well established. 
But in addition it may be said that the more one 
admits of protection to new industries in such a country 
the more one arouses a general demand for protection 
on the part of other industries. Industries may be 
new, but it does not necessarily follow that their 
establishment is a matter of difficulty on account of 
existing foreign competition. If the new industries 
are simply further developments of existing industries, 
there is hardly a case for protection on the grounds 
of newness. If, on the other hand, they are not con- 
nected with any existing industry and have to be 
built up from the ground, their case comes under the 
same general arguments as those which support pro- 
tection to infant industries in a new country. 

On the whole, we may sum up the argument in favor 



298 AN INTRODUCTION TO ECONOMICS 

of protecting infant industries by admitting that 
there is a great jiistilication for protection, but that 
a considerable difficulty is caused later by the fact 
that it is next to impossible to persuade those in con- 
trol of an industry that the period of infancy has 
passed, and a further difficulty is the creation of a 
feeling that protection is a natural state of industry. 
It is noticeable that when industries cease to be infants, 
those in control demand the continuance and even 
the increase of protection on quite different grounds, 
and we shall now, therefore, proceed to the discussion 
of some of those additional arguments. 

The National System — The discussion of this 
second basis of protectionist arguments really belongs 
to the field of political science. If we assume that 
the true purpose of economics is to show under what 
conditions the world may make the best use of its 
economic possibilities, we are inevitably led to the 
conclusion that the doctrine of comparative advantage, 
or, as we have previously called it, the law of compara- 
tive cost, must have the freest possible play. The 
law of comparative cost is only the application of 
the principle of division of labor on a wide scale, 
a division according to territories instead of accord- 
ing to individuals. Anything which hinders this 
free play is, therefore, a hindrance to the fullest eco- 
nomic development, and consequently a protective 
system, which is designed as a hindrance to such free 
play, helps to prevent that full economic develop- 
ment. 

The free economic development of the world, how- 
ever, takes no regard of national aims. It is dis- 



PROTECTION AND FREE TRADE 299 

tinctly international in its character. National aims 
presuppose the possibility and indeed the probability 
of mutual antagonism between nations. Hence it 
is not considered an unmixed blessing that the whole 
of the world's development should be in strict accord 
with its economic possibilities. Each nation, accord- 
ing to the supporters of the national point of view, 
must regard itself as complete, a separate and well- 
defined entity. Within the nation the greatest possible 
economic development may take place. But that a 
nation should be dependent upon another for any 
commodity or service which it could provide itself, 
would be a reduction of the national strength. 

The strongest case is made out in times of war. 
At such a time it may be essential that each country 
should be as self-supporting as possible. The more 
a country approaches to the state of a complete eco- 
nomic unit, the less the danger of its being starved 
through a blockade, or forced to surrender through a 
lack of means to produce munitions of war. 

Granting the importance of securing this economic 
unity, how does the protective principle affect the 
solution of the difficulty .f* Purely by preventing 
the operation of the law of comparative costs. If the 
desires of a people remain constant, the prevention 
of the satisfaction of these desires through foreign 
commerce leads to the demand for domestic production, 
and hence industries which, in a state of free compe- 
tition with foreign countries would not stand a chance 
of existence, are brought into being and may flourish. 

Obviously this is not done without a loss to the 
community. Whether the loss is commensurate with 



300 AN INTRODUCTION TO ECONOMICS 

the gain secured by reason of the attempted economic 
independence in time of war, is indefinite. Granted 
that a war takes place, it does not necessarily follow 
that the countries involved will be compelled to depend 
upon internal resources for all economic needs. A first- 
class war, in these days, seldom confines itself to two 
nations. The late war is an illustration of the position. 
It is extremely doubtful whether the war would have 
been more satisfactorily conducted, from the point 
of view of either side, had the countries concerned 
been individually economic units, or had they even 
approached this state. 

On the other hand, in order to secure this problem- 
atical 'advantage in the case of war, the community 
is undoubtedly saddled with a very considerable 
addition to the cost of its necessities, which means a 
corresponding decrease in the possibilities of internal 
development. 

The foregoing argument is based on the assumption 
that a protective system would be successful in securing 
a comparative economic unity. It is not possible, 
however, for any system to do more than limit a 
country's dependence upon external supplies. Many 
of the necessities of our present life are capable of 
being produced only in limited areas of the world's 
surface, and as these products must be paid for by 
the exchange of goods a certain amount of interna- 
tional trade is essential. 

From the point of view of the nationalist argument, 
therefore, the protectionist method results in the 
payment of a very heavy price, increasing with the 
success of the method, for a problematical advantage. 



PROTECTION AND FREE TRADE 301 

The Mercantilist Argument — We now turn to 
another protectionist argument which has enjoyed 
a great deal of support from protectionists of earher 
days and, indeed, through some of its terminology, 
remains popular to the present time. The school of 
economists who preceded Adam Smith in the middle 
of the eighteenth century were known as mercan- 
tilists. It is not necessary to discuss the whole body 
of their economic doctrines, but we must take notice 
of the chief, or one of the chief ideas that they pro- 
mulgated. The mercantilists laid stress on money 
as an indication of national wealth. They were 
inclined to believe that the wealth of a country varied 
directly with the amount of gold and silver that it 
possessed. Hence they urged that such measures 
should be adopted by government, in its regulations 
of commerce, as would secure the greatest influx of 
the precious metals into the country, and at the same 
time prevent their export. 

They argued that if the amount of exported mer- 
chandise exceed the value of the imported, the dif- 
ference must be paid in coin, and hence the excess of 
exports over imports necessarily resulted in an influx 
of gold to pay for the difference. This difference 
they spoke of as the " balance of trade." When 
exports exceeded imports the balance was said to 
be in favor of the exporting coiiSitry, and vice versa. 
We still hear these terms used in discussion of tariff 
problems and indeed other economic problems, but 
we already know from our discussion of the principles 
of international trade, that the term balance of trade, 
as used by the mercantilists, was meaningless. 



302 AN INTRODUCTION TO ECONOMICS 

Where these thinkers were at fault was in their 
consideration of visible exports and imports alone. 
They were not aware of the now well-recognized fact 
that the invisible exports and imports account for a 
great deal, if not all of the so-called balance. Even 
if we suppose it to be true that the best index to a 
country's wealth consists in the amount of gold within 
the country, the actual facts do not show that an 
excess of visible exports over visible imports leads 
to an influx of gold. As we have already seen, the 
movements of gold are controlled by totally different 
factors. 

But it is surely obvious that the possession of gold 
is not an indication of national wealth. The point 
is so trite that it is not worth considering. Indeed 
it is surprising that the mercantilists themselves did 
not realize the full extent of their fallacy with the 
amount of historical refutation available to them. 
At any rate, such a belief is inexcusable nowadays. 

Cheap Labor — Another argument which is fre- 
quently used in support of the continuance of pro- 
tection is what is known as the " cheap labor " ar- 
gument. It is pointed out that American labor is 
comparatively highly paid and hence the labor cost 
of the American product is high in proportion. The 
American manufacturer is, therefore, handicapped in 
competing with the' foreigner who uses cheap labor. 
It is made a strong point that the protection is required 
not so much for the manufacturer as for the workmen 
themselves. 

Investigation of this argument, however, shows that 
it is not so strong as appears at first sight. In the 



PROTECTION AND FREE TRADE 303 

first place there is a distinct fallacy in the statement 
that high wages mean high labor cost. This by no 
means follows ; in fact, it is usually the reverse. High 
wages are apt to coincide with a high degree of machine 
work and eflficiency and as a consequence, it often 
follows that high wages lead to reduced labor cost. 
If this is the case, and it is demonstrably true in a 
great many instances, the argument that protection 
is required to prevent the evils of competition from 
cheap labor, falls to the ground. The inefficiency 
of cheap labor is notorious, or should be to any one 
who has spent a short time in studying the working 
cost of Asiatic productions and the labor cost of cheap 
labor products in Europe. The yellow peril need 
not cause much fear if the true facts of labor cost are 
understood. 

Dimiping — One final argument we shall notice. 
It is claimed that a country should protect its producers 
from the competition of " dumped " foreign goods. 
What is meant by dumping .^^ Cheap production 
may often best be secured through large-scale opera- 
tions, but the highest returns may be obtained by a 
comparatively small home sale at a relatively high 
price. If this idea is followed out a manufacturer 
may sell part of his product in the home market, 
carefully restricting the supply available for that 
market in order to reap the high price. What is 
left of his stock he can afford to dispose of at a reduced 
price in some other market. Hence he sells the 
remainder to a foreign buyer at a low price, possibly 
covering cost, possibly even at a loss, for anything 
received for this amount which he definitely with- 



304 AN INTRODUCTION TO ECONOMICS 

holds from the home market is so much profit. This 
cheap disposal to a foreign country is known as "dump- 
ing." A careful study of the process, however, will 
show th^t dumping is only possible under certain 
conditions. The product must be in the nature of 
a monopoly; otherwise the market could not be held 
up to the high price at home. Even then the production 
must be operated under the law of increasing returns. 
For if this is not the case there will be no profit in 
producing the extra quantity of goods which are 
dumped. This extra amount would increase the 
relative cost, or cost per unit, and therefore reduce 
the home profits instead of adding to them. 

Dumping at a price less than cost, or even at cost, 
is only possible for a certain length of time. The 
prevailing high prices in the home country, which 
provide the means of sustaining the dumping process, 
are sure, sooner or later, to arouse competition. This 
will reduce prices and so prevent the continuance of 
dumping without the serious risk of bankruptcy. As 
a temporary expedient many firms who have tried it 
have found dumping to be unsatisfactory.^ 

In this discussion of the protectionist and free trade 
doctrines we have carefully refrained from the use of 
statistics. There is no greater danger to the satis- 
factory discussion of economic problems than the 
use of statistics by those who are untrained. It has 

^ This spasmodic dumping has been criticized as causing irregular work, 
tending to spoil reputation because quality and costs are cut keenly. The 
president of the United States Steel Corporation spoke of this sort of 
dumping as a kind that "does not develop continuous business." (Testi- 
mony of the government suit against the Steel Corporation. 1913, x, p. 3843.) 



PROTECTION AND FREE TRADE 305 

been said that figures will prove anything. If the 
principles of statistical science are followed out this 
statement is not true, but an unscientific use of statistics 
will often bolster up an argument which is really 
untenable. 



CHAPTER XXIII 

INVESTMENT AND SPECULATION 

The Flow of Capital — We have ah-eady had occa- 
sion to refer to the flow of capital. This must now 
be considered a little more fully. Our definition of 
the term included " that form of wealth which is 
used for the production of more wealth." This 
definition is unaffected by the ownership of the capital. 
The owner of wealth who desires to use it for the pro- 
duction of more wealth does not necessarily have to 
employ the capital himself. He may lend it, for a 
consideration, to others who will use it in their business. 
The transfer of the capital from the owner to the 
user does not alter its character. 

We may take it as a fundamental fact that, other 
things being equal, the owner of the capital desires 
to obtain the greatest -return possible from its use. 
The limitation is important, for the element of the 
safety of the capital is one which deserves careful 
consideration. Of two methods of using capital, 
both of which are equally safe, that one will be chosen 
which promises the greater return. Hence capital 
which is employed in a business which does not lend 
itself to the earning of the largest returns consistent 
with safety is always liable to be transferred to another 
industry or occupation where the profits are higher. 
This is only true, however, of liquid capital. Fixed 

306 



INVESTMENT AND SPECULATION 307 

capital cannot be easily transferred. It is not true, 
for instance, that because the automobile industry 
promises greater returns to capital than the cotton 
industry, cotton factories will therefore be turned 
into automobile plants. On the other hand, a firm 
which has been engaged in manufacturing bicycles 
may realize that greater profits could be obtained 
by making motor cycles and may comparatively easily 
adapt its machinery to such production. This is 
possible only where the fixed capital employed in the 
old business is capable of being used in the manufacture 
of the new product with comparatively little change. 
How then does capital flow from one industry to 
another ? 

Investment — There is always a certain amount of 
what is known as liquid capital seeking employment. 
This capital is always represented by money or the 
equivalent of money. That is to say, it is not fixed 
capital. It may be converted into fixed capital, of 
course, for money and its equivalents imply a com- 
mand of fixed capital. This money is open for invest- 
ment. That is to say, the owners are not, as a rule, 
desirous of using the capital themselves. They are 
willing that others should use it, provided they receive 
a share in the profits resultant from its use. 

Merchants and manufacturers who do not themselves 
possess sufficient capital for their own requirements, 
and who could use more with satisfactory results, 
invite the owners of idle capital to lend them their 
funds, or to " invest them in the business." The 
investors do not necessarily lose control of their capital. 
In most cases the fact that they have invested funds 



308 AN INTRODUCTION TO ECONOMICS 

in a business gives them the right to a say in the man- 
agement of the business, proportionately to the amount 
invested. Apart from this fact, however, they are 
always at liberty to sell their holdings to others, if 
they can find purchasers. In this way the fixed 
capital remains with the business. All that changes 
is the ownership. 

The profits resulting from the employment of capital 
may be used in two ways. Either they may be used 
for the purchase of consumption goods; that is, goods 
to be used in the satisfaction of ultimate wants, or 
they may be invested in business. With the former 
use we are not at present concerned. The latter, 
however, is the method by which the flow of capital 
is secured. 

As we have said, capital flows toward those occupa- 
tions which provide the greatest returns, other things 
being equal. There is always a point at which capital 
will cease to be employed in any business. That 
is the point at which the profits are not suflScient to 
provide more than the necessary expenses of opera- 
tion. This statement, in practice, requires a cer- 
tain modification. Investors do not always look to 
immediate results. It is quite possible for capital 
to be attracted toward an industry or business which 
at the moment is not earning profits. In these cases, 
however, the investors hope that the future profits 
will be such as to offset the temporary lack of earnings. 

But in the ordinary case where a business has ceased 
to earn profits in excess of the operating expense, 
those who have invested their funds in the business 
will endeavor to sell their holdings even at a loss. 



INVESTMENT AND SPECULATION 309 

in order that they may invest the proceeds in some 
business that is actually earning profits. They realize 
that it is better to earn a profit on a small investment 
than nothing on a large one. The buyer of the shares 
justifies himself with the belief either that the business 
is likely to improve, or that in liquidation he will 
receive a sum greater than that paid for the shares. 
Usually it is the former which decides the purchase. 
Occasionally, also, the holder of an investment desires 
to use his funds for the purchase of consumers' goods, 
in which case, all that happens is that the ownership 
of the investment changes hands. 

Par and Investment Price — In the buying and 
selling of invested capital there is a great deal of price 
fluctuation. Leaving out of consideration, for the 
present, fluctuations due to speculative causes, the 
changes in price are primarily due to changes in 
the earning power of the business. Following out the 
laws of supply and demand, which we have already 
studied, there is a tendency for the returns to the 
investment to be averaged fairly evenly. Given 
equality of security, for instance, we may say with a 
fair degree of accuracy, that the returns to one invest- 
ment will tend to equal those from another of the same 
amount. To illustrate this, let us suppose that by 
investing $1000 in a certain business a return of 4 
per cent is secured. Let us suppose that the average 
rate of interest is 5 per cent. No person who buys 
the investment of $1000 from the original investor 
will give $1000 in payment. His reasoning is simple. 
By investing $1000 at the average rate he can obtain 
5 per cent. Why, therefore, should he pay for an 



310 AN INTRODUCTION TO ECONOMICS 

investment which will only yield 4 per cent? He 
offers, let us say, $800. If the sale is made, then the 
new holder of the investment receives as interest on 
his shares 4 per cent on the original $1000, or $40. But 
as he only paid $800 for the investment, the actual 
amount earned on that $800 is equal to a rate of 5 
per cent, the average rate. 

If, on the other hand, the average rate of interest is 
3 per cent, the holder of the original $1000 shares 
will not sell at par, or face value. If he did, and then 
tried to invest the $1000 again, he would only gain 
3 per cent instead of four. He demands a higher 
price and the sale is made at about $1300, which 
gives a rate of approximately 3 per cent to the pur- 
chaser. When shares are sold at their face value, 
they are said to be at par; when sold at less than 
par value, they are sold at a discount, and when sold 
at more than par, they are at a premium. Shares, 
therefore, tend to be at a premium when the rate 
earned is greater than the average rate and at a dis- 
count when it is less than the average rate. 

The Future Element in Business — This is simple 
enough to understand if we consider the price as being 
entirely determined by the present earning capacity of 
the business. But the investment market is very 
easily influenced by hopes and fears. In fact it would 
be almost safe to say that the hopes and fears have a 
greater influence on the market than present conditions. 
Now the causes which produce and influence these 
hopes and fears are innumerable. Hence there is a 
constant fluctuation in the value of investments. 

The future element in business is not confined to 



INVESTMENT AND SPECULATION 311 

stock and share investments, however. In every 
aspect of business the future is to a certain extent 
discounted. The prices of commodities are affected by 
the prospects of increase or decrease in the supply, a 
possible scarcity in the future leading to a holding of 
stocks for the future market, thus raising prices in 
the present market by reducing the effective supply, 
and reducing future prices by increasing the future 
supply. 

Speculation — It is the future element in business 
which gives rise to speculation. There is hardly any 
more controversial subject than the question of the 
values and evils of speculation. In order that we may 
examine this question in a satisfactory manner we 
must be quite clear as to the meaning of the term. 
Like many others, it is used with great laxity of mean- 
ing, and without careful definition no argument is 
possible. 

In every meaning which is attached to the term 
speculation, there is one common element, that of 
future uncertainty. The greater this uncertainty, 
the greater is the speculative element. But future 
uncertainty is ever present in life, and business is 
peculiarly subject to it. Any man who undertakes 
to supply some of the needs of the community runs 
the risk of misjudging those needs, or of not being 
able to satisfy them at a price remunerative to him- 
self. He runs the risk of being forced out of business 
by competition, by inability to do the work properly, 
by lack of capital, by failure in the supply of raw ma- 
terials, by convulsions of nature which destroy the 
economic value of his situation, by the vagaries of the 



312 AN INTRODUCTION TO ECONOMICS 

weather, and so on to infinity. Any man who wishes to 
enter business and avoid these risks is asking the 
impossible. In so far as he accepts these risks he is 
speculating. That is, he is taking a chance that his 
future profits will not be seriously interfered with 
by these possible future dangers. 

No one will attempt to deny that this sort of specu- 
lation, the risking of the inevitable dangers of com- 
mercial life, is justifiable. It has its evils, no doubt, 
but these evils are inherent in commercial life and 
cannot be avoided. No one has any respect for him 
who wraps his talent in a napkin and buries it. 

But these inevitable risks are minimized to the 
greatest possible extent by the wise business man. 
A good farmer does not plant his seed without consid- 
ering first the possibility of getting the crops to market. 
The banker does not invest the capital of a metro- 
politan bank in a little country town. Still, no matter 
how great the care taken, losses are bound to occur. 
All that can be done is to minimize the losses and 
spread them over as large an area as possible so that 
the blow to the individual will be lightened. 

In many discussions of speculation great stress is 
laid upon the form which we have just described. 
But the discussions lack life, for the common use of 
the term practically ignores that form of its application. 

Stock and Share Investment — We have already 
seen that in the sale and purchase of stocks and bonds 
we have the mechanism for the flow of capital. Assum- 
ing the existence of the free play of competition in an 
open market, the rate of profit on industry is determined 
by the ability displayed by the manufacturer or mer- 



INVESTMENT AND SPECULATION 313 

chant in satisfying the demands of the community, 
or by special circumstances which give him a pecuHar 
advantage in producing the goods or services required. 
Loss occurs when the demand of the community 
does not exist or is not of sufficient strength to justify 
the amount produced. Hence the flow of capital 
tends to insure that those services which are desired 
by the community attract the necessary amount of 
capital to cause their production. 

The owner of capital which is free for investment 
must keep a keen watch upon the growing needs of 
the community. If his judgment shows him that a 
particular commodity or service is likely in the future 
to be in greater demand by the community, he takes 
prompt advantage of that judgment to invest his 
capital in the production of that commodity or service 
so that he may reap the profit bound to be realized 
as the public demand grows. He may be said to 
render a public service in that he anticipates the need 
of the community and provides satisfactions for its 
desires as soon as they arise. 

It may be, of course, that his judgment is in error, 
and he reaps the fruits of that error by unnecessarily 
increasing a supply and consequently decreasing the 
price of some commodity. The result is a loss, not 
only to him but to other producers who were first 
in the market. If we assume that, on the whole, he 
is correct in his anticipations, then he prevents the 
sudden rise in prices consequent upon a sudden increase 
in demand with a constant or decreasing supply. 

To make this more clear, let us take an illustration. 
Let us suppose that a certain investor foresees that, 



314 AN INTRODUCTION TO ECONOMICS 

owing to the discovery of some new method of pro- 
viding the generating force for electricity there is 
likely to be a great increase in its use. The result 
will be a considerable increase in the demand for 
copper, rubber, etc., for conductors and insulators. 
He invests his capital in the production of copper 
and to that extent increases the supply of copper. 
As the demand for copper materializes the supply 
is shown to be more nearly adequate to the demand 
than would otherwise have been the case, and while 
there may still be an increase in price, the increase 
is not so great as it would have been had there been 
no increase in the supply. The public is, therefore, 
able to reap the benefit from increased use of electric- 
ity without having to pay an unduly high price for 
copper. 

The cases referred to above, however, only refer 
to speculative investments and not to pure speculation. 
If all speculations were carried on w^ith the idea of 
reaping profits through the intelligent anticipation 
of the future needs of the public, there would be little 
criticism. Moreover, there would be no desire to 
juggle with the prices of stocks and bonds. But a 
vast amount of speculation has no real relation to 
the investment of capital. The speculators do not 
invest; they merely play with the rises and falls in 
prices of different securities. This amounts to mere 
gambling and in spite of a certain amount of specious 
arguing to the contrary, there can be no economic 
justification of these operations. 

The Method of Stock Exchange Speculation — In 
order to understand this matter better, let us consider 



INVESTMENT AND SPECULATION 315 

the methods of the stock exchange speculator. Sup- 
pose he has a capital of $20,000 with which to operate. 
He decides that a certain stock, let us say, Montana 
Copper, is due to rise in price. His reasons for think- 
ing this copper company's stock will go up may be 
due to careful consideration of the copper market, 
or they may be due to " inside information " that a 
bigger than usual dividend is to be declared ; or he 
may hear that some big operator is planning to get 
a controlling interest in the mine, or any other of a 
multitude of reasons. Whatever they are, however, 
he decides to buy. He places an order with his broker 
to buy a thousand shares at the market price which 
is, let us suppose, 110. This would appear to call 
for a capital of at least $110,000, which is more than 
he possesses. He does not pay for the stock himself, 
however, he merely " puts up a margin " of ten points. 
That is he pays about ten per cent of the price to his 
broker. The broker on the strength of the deposit 
of securities with the bank obtains a call loan for the 
balance. The actual amount which the speculator 
has paid the broker is $11,000. Now if the shares 
go up in price to 120 and at that figure the speculator 
thinks they will stay, he sells out. The broker, there- 
fore, pays to him the difference between the price at 
which he bought and the price at which he sold the 
shares, together with his margin, deducting the usual 
commissions. 

Our speculator, therefore, has received from the 
broker approximately $22,000, making a profit of over 
$10,000. If the stock had gone down instead of up, 
the broker would have asked the speculator to support 



316 AN INTRODUCTION TO ECONOMICS 

his margins. The broker requires a, ten-point margin. 
As the stock goes down in price the broker knows 
that he will receive less than he paid for it if he sells. 
As long as the difference between the purchase and 
selling prices is less than the amount deposited by 
the speculator the broker is safe, for by selling the 
stock he gets the bulk of the price back and the dif- 
ference he makes good by drawing on the deposited 
margin. If the stock falls ten points instead of rising, 
the speculator may still keep the stock by paying 
additional amounts to the broker. The further it 
falls, however, the more he has to pay in and there 
comes a time when he can pay no more. The broker 
sells the stock " at the market " and the difference 
is made good out of the speculator's margins. 

It will be noticed that this speculation has not 
helped the industry in the slightest. In fact there 
has been no investment at all by the speculator. He 
has never actually held the stock at all. The stock 
has really been held by the bank which made the 
call loan. The speculator has merely made a bet 
that the stock would rise. If he wins the bet, he 
profits. If he loses, some one else profits. In any 
case it is practically certain that he never sees the 
stock he is dealing in. 

The case is still clearer when the speculator is sell- 
ing " short." He may believe that a certain stock, 
of which he has none, is likely to fall. He orders his 
broker to sell that stock, and relies upon being able 
to buy stock at a lower price in order to deliver it to 
the person to whom his broker originally sold the 
stock. If the stock goes up instead of down, he must 



INVESTMENT AND SPECULATION 317 

still buy it in order to make delivery to his purchaser. 
He buys therefore, at a higher price than that at 
which he sold and so loses on the transaction. Again 
there is no investment, for he sells before he owns 
the stock and as soon as he does own any he transfers 
it to his original purchaser. 

Grain and Produce Speculation — The same meth- 
ods are used in the speculation in grain and other 
produce. Men who would not know the difference 
between wheat and barley if they saw the two together 
may speculate on the crop markets. Crops are bought 
and sold before the seed is planted and the total amount 
of transactions probably far exceeds the total value 
of the crop when it is actually reaped. 

Speculation and the Stability of Prices — Theoreti- 
cally it is often argued that the speculation in futures 
tends toward stabilizing prices, that is, preventing 
the extension of the price fluctuations. The argument 
is simple enough — we have already outlined it in 
regard to investment. If prices are high at present 
and the speculators believe that they will fall, they 
sell. But the fact that they sell now tends to lower 
the price. As soon as the price seems likely to increase 
they buy, thus helping the price to rise. But as they 
prevent a high price from going higher and a low price 
from going lower, they are therefore helping to keep 
prices level. This argument is not true to the facts, 
however, for it is seldom that a speculator sells in a 
market which is rising. He usually " follows the 
market." If he sees prices falling, he acts on the 
opinion that they will fall farther and hence helps 
them to fall. If they rise he seems to believe that 



318 AN INTRODUCTION TO ECONOMICS 

they will rise farther and so he buys, thus helping the 
price to cHmb. 

As a matter of fact, there cannot be the slightest 
doubt in practice that, far from helping to stabilize 
prices, speculation tends to increase the fluctuation, 
even when it does not do so deliberately. 

In the stock market the prices that are paid for 
stock often have not the remotest connection witli 
the actual value of the stock. For example, we may 
cite the price of Northern Pacific stock which went 
as high as $1000 for the $100 share during the fight 
between James J. Hill and E. H. Harriman for control 
of the road. This price was absolutely unconnected 
with the actual value of the shares in that railroad 
company. Again in the famous Boston gas war, 
the prices of shares had no relation to the normal 
value of the stock of the various companies concerned. 

Psychological factors are of immense importance 
in the stock market. A stockholder may be thor- 
oughly convinced that his stock is worth what he 
paid for it. But let him see continuous heavy sales 
at lower and lower prices and he will feel more and 
more uncertain. As the prices fall he will gradually 
feel that he must realize on his holding at once lest 
their value disappear. This psychological factor is 
realized by the stock manipulators and it is, unfor- 
tunately, no uncommon thing for a valuable stock to 
be " beared " so that the " bears " may afterwards 
buy it in at a small price. 

Control of Speculation — The control of speculation 
is extraordinarily difficult. It is admitted that the 
genuine purchase and sale of stocks is valuable as 



INVESTMENT AND SPECULATION 319 

society is organized at present. But there is no differ- 
ence in technique between a genuine sale and pur- 
chase and a speculative one. Hence schemes which 
would effectually control speculation at the same time 
control investment. The stock exchange has rules 
which must be observed by its members. But there are 
always the curb brokers and there are ways of break- 
ing the rules without appearing to do so. We have 
no space to go into the technique further. The ques- 
tion of the control and regulation of stock exchange 
gambling is one which must receive careful attention 
by the public and its representatives in Congress. 



CHAPTER XXIV 

RENT, INTEREST, AND PROFITS 

Distribution as an Economic Problem — Much 
of our previous discussion has been concerned with 
the problems of production and exchange. We must 
now turn to another element in economic life — the 
distribution of the products. This problem is not 
to be confused with the difficulty of mechanical trans- 
portation. The word distribution is used in another 
sense. When goods have been produced there always 
arises the question as to the ownership of the goods. 
When work has been done there arises the question 
as to the price to be paid for the labor. If we consider 
labor merely as a peculiar form of goods, then, of 
course, we can deal with it under the general laws 
of exchange which have already been discussed. We 
shall see, however, that labor, or rather, laborers 
refuse to allow themselves to be considered in that 
manner nowadays. Indeed it is not only the laborers 
who refuse. Governments also, in every civilized 
country, take certain steps to prevent labor from being 
so regarded. Let us put the problem concretely. 
Suppose a factory turns out goods which are sold for 
one million dollars. Suppose further that the cost 
of the materials from which those goods were made 
amounted to $250,000. How is the balance to be 
divided ? 

320 



RENT, INTEREST, AND PROFITS 321 

Now in any ordinary concrete case it is simple to 
enumerate the different recipients. In the first place 
the laborers (including within the term those who work 
by brain as well as hand workers) must receive a cer- 
tain share. Those who supply the capital require 
a certain amount for the loan. Those who provide 
the land and buildings upon and in which the goods 
are made must receive their payment. If anything 
is left we may provisionally regard it as profits. 

This is one aspect in which the problem of distribu- 
tion may be regarded. It is impersonal, for we are 
merely trying to divide the proceeds into the ratios 
suitable to the value of the different factors in pro- 
duction — land, labor, and capital. There is another 
aspect, however, which is of considerable, if not of 
paramount, importance. One of the greatest problems 
which confronts the economic world is the problem 
of riches and poverty. Why should one man receive 
a great share of the proceeds of the world's economic 
efforts, and many others have to accept very small 
portions ? In simple words, why should one man 
be poor and another rich? We may speak of that 
problem as the problem of the personal distribution 
of wealth to distinguish it from the first. 

In this latter form of distribution the ethical aspect 
is of great importance and cannot be ignored. It is 
too important to be considered in a subsection and 
will, therefore, be dealt with more fully in the next 
chapter. The discussion of the distribution between 
the various factors of production may be considered 
purely analytically, and the present chapter will deal 
with the reasons for the payment of rent, interest, and 



322 AN INTRODUCTION TO ECONOMICS 

profits, leaving the wage question for future con- 
sideration. 

It is important to realize, however, that in discussing 
these reasons we are not necessarily implying that 
rent and interest and profits are inevitable under 
any system of economic organization. The fact is 
that payments are made to the owners of land, to the 
owners of capital, and to the owners or operators of 
businesses and it is important to realize why these 
payments are made. 

Rent — Let us suppose that in a certain community 
there is available for agricultural purposes 1000 acres 
of land, and also that the only crop is wheat. If all 
this land is of equal quality and can, therefore, produce 
wheat at an equal cost, no question of differences in 
payment for the land can arise. If the cost of raising 
wheat, including the payment for the necessary farm 
labor, seeding, depreciation of implements etc., be 
30 cents a bushel, then the wheat cannot be sold 
for less than that amount (we must ignore temporary 
and peculiar conditions of different farmers). If it 
were, the wheat would cease to be produced. Now 
if the wheat is just sufficient for the needs of the com- 
munity, the price will be just equal to the cost of pro- 
duction, i.e., 30 cents a bushel. It cannot go above 
30 cents, for if it did competition between the farmers 
would bring it back again. 

Our assumption, however, is never warranted by 
the facts. The land is not of the same quality through- 
out. If all be capable of producing wheat, the cost 
of production will vary with different farms. One 
farmer will be able to produce at 30 cents a bushel. 



RENT, INTEREST, AND PROFITS 323 

but another will only be able to raise his wheat at 
a cost of 35 cents, another at 37 cents, and so on. Now 
suppose there is sufficient land of the highest quality 
to produce all the wheat desired by the community 
at a cost of 30 cents a bushel. Obviously only 
the best land will be cultivated. The demand will 
exactly equal the supply. Now suppose the demand 
goes beyond the amount which can be produced at 
30 cents a bushel. Suppose, for instance, that 
the competition for wheat raises the price to 35 cents. 
In that case it is worth while for the farmer to culti- 
vate some of the poorer land. This means, however, 
that those who till the better land gain an extra price, 
above the cost of their labor, etc., of 5 cents a bushel. 
In order to obtain this increase farmers will be willing 
to offer payment for the use of this better land. If 
30 bushels to the acre are produced, the farmers will 
be willing to pay a sum not exceeding $1.50 an acre 
for the use of this land. If they make that payment, 
they still have the opportunity of selling their wheat 
at a price which will repay them for the cost of pro- 
duction. No one, however, will be willing to pay 
for the cheaper land, for the price to be gained is only 
sufficient to pay for cost of production. 

This price paid for the use of the better land is 
known as reyit. The student will naturally reply 
to this statement, that rent is paid even for the poorest 
land that is cultivated and that some of the best land 
is worked by the owner who pays iio rent. Let us 
examine this. All land upon which wheat can be 
grown is not cultivated. The reason why some is 
not used is that the price to be obtained from the wheat 



324 AN INTRODUCTION TO ECONOMICS 

is not sufficient to repay the cost of cultivating it. 
Also, it is a fact that the poorer the land, the smalkr 
the rent which is actually paid. Now, if the demand 
for wheat is such that the existing supply from llic 
cultivated land is not sufficient, the price will li.c 
until it reaches the point where the hitherto unculti- 
vated land is worth farming. This means that a rent 
will be offered for the land which was of the poorest 
quality actually cultivated before, for this land is 
now able to produce wheat which sells at a higher 
price than that necessary merely to repay the farmer 
for his cost of production. It is obvious that no one 
will pay for anything which means a steady loss to 
him. Hence nothing will be paid for the land which 
merely repays the cost of production of the wheat. I 
This land may be said to be on the margin of cultiva- 
tion, for it is the last to be cultivated. Any land which 
is above the margin of cultivation earns a rent. 

Now as to the non-payment of rent by the owner of 
high-class land which he farms himself. In selling 
his produce he receives more than is necessary to 
repay the cost of production. It is assumed that he 
will farm the land even if he does not get this addi- 
tional price. Therefore the increase in price over 
the cost of production is in the nature of a producer's 
surplus, and is to be regarded as rent which he pays 
to himself. Obviously, if he were to relinquish farm- 
ing himself, and turn the farm over to a tenant, the 
latter would pay a rent. Whether the rent is paid 
to the farmer himself, as owner, or by a tenant to the 
owner, is immaterial. 

The rent is a payment made for the inherent qualities 



RENT, INTEREST, AND PROFITS 325 

of the land, the quahties endowed by nature. Rent 
only appears when other lands of poorer quality are 
forced into cultivation by the demand for the agri- 
cultural product. 

Urban Rents — Rent is not only paid for agri- 
cultural land, however. It is also paid for land in 
cities where no agriculture is carried on. A man pays 
" rent " for the use of a building. This use of the 
word rent, however, is not accurate according to our 
definition. The payment is made not for one reason, 
but for two. In the first place it is made for the land 
upon which the building is situated. Secondly, it 
is made for the use of the building itself. But the 
building is not a natural product. It gradually deteri- 
orates with age. The payment for its use, therefore, 
is rather a payment for the building itself upon the 
installment principle. There comes a time when the 
building is no longer of any value ; it has served its 
purpose and become worn out. No " rent " will be 
paid for it then. So the rent paid in a city is still 
to be regarded as a payment for natural values. 

The natural values of urban land, however, are 
not the same as those of agricultural land. In the 
city the land value varies according to its situation. 
If it is to be used for the purpose of selling goods, 
the rent will depend upon its comparative value as 
a suitable situation. More will be paid for land in 
the shopping center of the city than in the outlying 
districts. Land upon which oflSces are to be built 
will command a higher rent if situated near the com- 
mercial center. If factories are to be erected, then 
the higher rents will be paid for those situations which 



326 AN INTRODUCTION TO ECONOMICS 

are close to good transportation facilities. In every 
case, however, the principle is the same as in that of 
agricultural land. We may define rent, therefore, 
as the amount paid for the use of land in excess of 
the amount paid for land on the margin of cultivation. 

Quasi Rents — The idea of economic rent has been 
extended outside the consideration of the natural 
values of land. Some of the improvements made in 
past times have practically been incorporated in the 
land — ancient irrigation works, clearing of forest 
growths, and so on. These are not gifts of nature, 
but nevertheless, they give the land a comparative 
advantage in production which is somewhat like the 
gifts of nature and hence payment for this advantage 
is of the nature of rent. 

Again it is sometimes said that a man who has 
peculiar natural advantages obtains a " rent " for 
them. In the case of two piece workers, for instance, 
one of whom is quicker and more accurate than the 
other, the quicker man will be able to earn more in 
a day than the slower, so the amount he receives in 
excess of that paid to the other is somewhat similar 
to rent. These forms of rent are, however, better 
known as quasi rents. 

Interest — The next element to share in the dis- 
tribution of the produced wealth is capital. Pay- 
ment for the use of capital is termed interest. We 
have already seen that in the Middle Ages interest 
was regarded as immoral, and we have examined the 
reasons for that idea. We must now analyze the 
reasons for the payment for the use of capital. It has 
sometimes been argued that interest is paid because 



RENT, INTEREST, AND PROFITS 327 

the owner of the capital might have made a profit by- 
using the capital himself and that, as he foregoes the 
profit which he might have made, he is entitled to 
share in the profits made by the actual user. There 
is a great deal of truth in this argument, but it does 
not quite cover the ground. Many men ask and 
receive interest for the use of their capital, who would 
be unable to make any personal use of their funds as 
capital. Take, for instance, the man with a small 
savings account. The amount which he possesses 
may be so small that he is unable to finance a business, 
and the probability is that he is merely a wage earner 
himself and so does not provide capital for the business 
through which he gains his living. Nevertheless 
he expects to receive interest from his savings bank. 
Again, a man may have sufficient capital to work the 
business in which he is principally engaged. His 
business may be at the stage of diminishing returns. 
Any addition to the capital, therefore, would mean a 
return smaller proportionately than that gained by 
the actual capital. Unless he has some other business 
to which he gives his personal attention he is unable 
to employ that spare capital. Hence it would appear 
that he is not entitled to anything more than the 
return of his investment when he lends the capital. 

There is another reason for the payment of interest, 
however, which is more complete than the one we 
have just spoken of. In the discussion of the prin- 
ciple of marginal utility it was shown that there is a 
great difference in the marginal utility of a present 
satisfaction and a similar satisfaction in the future. 
Invariably the present satisfaction has a higher mar- 



328 AN INTRODUCTION TO ECONOMICS 

ginal utility than the future. Now when a person 
invests his capital he is denying himself a present 
satisfaction. In other words he is denying himself 
the satisfaction which he could obtain by buying 
consumption goods. In the case of the man with the 
small savings account, it is quite possible that the 
amount saved could have been used for the purchase 
of some little luxury which would have been keenly 
appreciated. Many thousands of these small savings 
represent real sacrifices of present utilities. It is 
only right, therefore, that the return of the capital 
saved should be accompanied by some amount repre- 
senting the difference between the present and the 
future utility. Let us take the famous illustration 
of the man who makes a plane, and lends it to a car- 
penter for a year. The maker of the plane demands 
at the end of the year the return of the plane in as good 
condition as it was when he lent it, together with a 
plank of wood. The argument here is not that the 
plane-maker could have used the plane himself during 
the period of the loan, but that he might have expended 
the energy used in the manufacture to make something 
which would have satisfied an immediate want. The 
carpenter who used the plane has produced goods in 
excess of the value of the plane itself, and as he has ob- 
tained present utilities from its use he must recompense 
the lender for his abstinence from a present satisfaction. 
The real justification for the payment of interest, 
therefore, is the fact that the lending of capital means 
an abstinence from present satisfaction and that there- 
fore the lender is entitled to the difference between the 
present and the future marginal utility. 



RENT, INTEREST, AND PROFITS 329 

It may still be argued, of course, that there are 
certain men whose wealth is so great that they cannot 
spend anything like the whole of it on consumption 
goods, and hence there is no real abstinence from present 
satisfaction on their part. This argument, however, 
brings in another consideration, involving the question 
of the personal distribution of wealth. It does not 
affect the statement that the purchase of consumption 
goods, i.e., the purchase of present utilities is foregone, 
and the difference between present and future utilities 
must be paid for. 

The question of the causes determining the rate of 
interest is too complicated for our present discussion, 
but a brief statement may be given. In the first 
place, security for the return of the principal is impor- 
tant. Assuming, however, that security is the same 
throughout, then the rate of interest will be determined 
by a sort of average of the estimated difference between 
present and future utilities. The average will be 
arrived at to a large extent by the relations between 
the supply and demand of investment capital. 

Profits — In general the term profits is used to in- 
clude the payment of interest on capital, while rent and 
wages are included in the cost of production. This, 
however, is merely the colloquial use of the term and 
we must eliminate these elements. So far, we have 
considered the returns from the sale of the goods or 
services as having provided for payment of cost of 
materials, for rent, and for interest on invested capital. 
It does not matter, of course, whether the owner of the 
capital conducts the business himself or not. A cer- 
tain amount is due for interest. There is, presumably, 



330 AN INTRODUCTION TO ECONOMICS 

a greater return than would be sufficient for these 
payments, even assuming that labor has been allowed 
for in estimating the costs of production. The pay- 
ment for managerial efforts and skill is rightly to be 
included in the cost of labor, and what is left over 
constitutes the profits. 

If we consider that rent, interest, and wages (includ- 
ing wages of management) have all been paid for, 
what justification is there for profits beyond these 
amounts ? There are two answers to this question. 
One is that profits are rightly to be considered as a 
form of rent. The entrepreneur, that is, the man who 
undertakes to conduct the business, has a certain 
amount of ability. The ability of different entre- 
preneurs varies, however. He who is simply able to 
make sufficient by his conduct of the business to pay 
for wages, rent, and interest, is in the position of the 
farmer on the margin of cultivation. One who makes 
more than that is reaping the reward of his additional 
ability. He is thus in the position of the farmer whose 
land is of better quality and thus a rent is paid. 

There is something to be said for this view. There 
does appear to be considerable similarity between 
the two positions and hence profits might be said to 
be a form of quasi rent. There are, however, other 
reasons which tend to refute the argument. In 
particular there is the question of risk taking. The 
undertaker has to assume risks which the mere lender 
of capital does not take. There are very many unfore- 
seen risks that are inherent in all businesses. Take 
the case of the cloth manufacturer, for instance. He 
manufactures cloth of a color to suit the existing ideas. 



RENT, INTEREST, AND PROFITS 331 

The fashions may change in a day, however, and new 
colors may be demanded. The stock of the old colors 
may be sold at a loss. Again he may be manufacturing 
in a certain situation where the transportation facilities 
are good. Gradually these facilities disappear ; the 
mouth of a river silts up, or a landslide occurs on the 
railroad and for months the track is useless ; floods 
prevent passing of railway trains, and so forth. Again 
a war may occur which prevents him from obtaining 
a proper supply of raw materials. All these are risks 
which he must take. 

Most of these risks may be estimated mathematically 
according to the laws of chance. Actuaries make a 
profession of estimating such chances. Each indi- 
vidual entrepreneur must also estimate the chances 
of loss by such risks. He, however, does not as a rule 
estimate the chances mathematically, but rather 
makes what we may call a subjective estimate which 
is invariably greater than the mathematical estimate. 
In order to be on the safe side he strives to obtain a 
price for his products which will enable him to bear 
unforeseen losses when they occur. The community 
has to bear the losses in fact, of course, but they are 
as it were distributed over a large area. The increased 
price relieves the consumer of any responsibility for 
the losses. If there were no such insurance of risk, 
it is doubtful whether production, under the present 
economic organization, could take place. 

To make a final analysis of profits, therefore, we may 
say that they consist of insurance against risk and rent 
of ability. In speaking of the insurance against risk, 
of course, we must not take the subjective estimate. 



332 AN INTRODUCTION TO ECONOMICS 

for that is too high. We mean the mathematical 
estimate. This, however, as we have said, is not the 
business man's method. He attempts to obtain as 
much as possible, merely making sure that the mini- 
mum is equal to his subjective estimate of the risks 
encountered in the conduct of the business. 

Summary Analysis — The distribution of the pro- 
ceeds of industry, therefore, may be summed up as 
follows : 

1. Rent, or payment for the use of land. 

2. Interest, or payment for the use of capital. 

3. Wages, or payment for labor, including the labor of 

management. 

4. Profits including : 

(u) Insurance against risks. 
(b) Rent of ability. 



CHAPTER XXV 
THE PERSONAL DISTRIBUTION OF WEALTH 

There are few problems which involve more con- 
troversy than that of the personal distribution of 
wealth. Ought each individual to receive an equal 
share of the total product, or is his share determined 
by causes over which society exercises no control ? 
If there exists inequality, as no one doubts, is the 
inequality growing greater as time passes, or less ? 
If there is a difference, to what is the difference due? 
We shall attempt an answer to some of these questions 
in the present chapter. 

Statistics — ■ The first difficulty which arises is 
that of securing accurate data upon which to base 
conclusions. This involves the use of statistics, and 
statistics are very difficult both to collect and to 
interpret. To attempt, in a book like the present, to 
discuss the statistics of the distribution of wealth 
is quite impossible. It is well to warn the student, 
also, that statistics is a difficult science, and none the 
less so, because many people think that they are using 
statistics when they are only quoting figures. Instead 
of giving actual figures and reasoning therefrom, we 
shall have to content ourselves with stating some gen- 
eral conclusions at which statisticians have arrived 
after careful consideration of the data obtainable 

333 



334 AN INTRODUCTION TO ECONOMICS 

not only from American, but also from European 
sources. 

The Present Condition — There can hardly be any 
doubt that the economic condition of every class has 
improved greatly during the last century or two. 
We must always remember that there exists a strong 
tendency to overestimate the evils of the present 
when comparing them with those of the past. It is 
commonly said, for instance, that the early colonists 
of this country lived in a state of rude comfort; a 
general largeness of living is suggested. As a matter 
of fact, more stress should be laid upon the rudeness 
than upon the comfort. The early colonist lived in 
a constant struggle against starvation. He had no 
comforts that would not be scorned nowadays by 
even the poorest. His working day covered the whole 
of the daylight and often part of the night. Our 
very awareness of the evils of the present conditions 
is an indication of improvement. But while we refrain 
from underestimating the improvement, we must 
not be blind to the existence of evils. Without detail- 
ing the failures of the modern system to secure an equi- 
table distribution of the world's wealth, we may at 
least mention a few of the more notorious facts. On the 
one hand we see the growth of personal fortunes which 
are beyond the wildest dreams of the oriental potentates 
of old. Croesus was a member of the lower middle 
classes compared with some of the money kings of 
to-day. On the other hand we find that in any great 
city of the world a large proportion of the population 
do not receive enough to maintain themselves in a 
state of bodily efficiency. It is estimated, for instance. 



THE PERSONAL DISTRIBUTION OF WEALTH 335 

that in order to maintain himself and his family of 
three children in a state of bare physical efficiency, 
without allowing for the slightest luxury, even for 
cheap amusement or an occasional pipe of tobacco, 
a workman ought to receive about $1600 per annum. 
It is further estimated that the average rate of pay for 
the American workman is less by some hundreds of 
dollars than that sum, after allowance is made for 
periods of unemployment. As we have said, the 
statistics of the subject are essential in making an 
accurate estimate of the inequalities of distribution 
of wealth, but for our present purpose we may assume 
that these inequalities exist and we may now proceed 
to discuss some of the causes which produce great 
wealth and, later, some of those which result in great 
poverty. 

The Causes of Wealth — It is well to remember 
that we seldom find one cause working alone. That 
does not destroy the value of an analysis, however. 
We shall not pretend that our analysis is absolutely 
complete, or that it is always scientifically accurate. 
There are occasions when it is almost impossible to 
separate one cause from another. We may, however, 
consider that there are four chief factors in the pro- 
duction of great fortunes. (1) Accidental causes, 
or those over which the fortunate individuals who 
gain the wealth have had no control. (2) Opportunity, 
often very similar to accidental causes, but differing 
in that often the individual must exercise considerable 
judgment in discerning the existence of and in seizing 
the opportunity. (3) Efficiency, where the wealth 
resultant is due to the superior capacity of him who 



336 AN INTRODUCTION TO ECONOMICS 

has gained it. (4) Monopoly, where the wealth is due 
to the possession of monopolistic privileges. 

I. Accidental Causes — Accidental wealth is often 
due to the discovery of unexpected mineral deposits. 
It may happen, for instance, that a man buys a farm, 
and later on discovers that the underlying earth con- 
tains a valuable bed of coal or some other mineral. 
The value of the land jumps at once to a sum vastly 
greater than that which was given for the land on 
the basis of its agricultural value. Before the dis- 
covery of the great value of mineral oil, for example, 
much of the land upon which oil wells have been drilled 
was of comparatively little value. The fact that the 
presence of oil is unknown to the individual who pos- 
sesses the land makes that presence a hidden factor 
in the value of the land. The accidental discovery 
of the oil is not due to the efforts of the individual, 
beyond, perhaps, the expenditure of effort on a few 
experimental borings, but nevertheless, the discovery 
of the oil may easily be the cause of a great fortune 
to the owner of the land. Two farmers have adjacent 
farms ; each bores for water, and one discovers oil 
instead. His farm leaps in value, while his neigh- 
bor's remains stationary, or at most, rises because of 
proximity to the oil and the possibility of oil existing 
there also. One farmer immediately becomes wealthy, 
while the other, should no oil be found, earns his living 
in the sweat of his brow. 

Again in the actual search for minerals, the element 
of accident plays a great part. This is seen in almost 
all of the great gold discoveries in California, Alaska, 
Australia, and South Africa. Some miners will spend 



THE PERSONAL DISTRIBUTION OF WEALTH 337 

the whole of their lives in the search for gold, with 
little success. Others, of no greater skill, make a lucky 
strike within a few weeks of the commencement of their 
prospecting. The lucky ones make great fortunes, 
while their equally skillful brethren gain a bare living. 

A new development of industry may cause the 
manufacturer of a hitherto slightly used product 
suddenly to find that he can command great prices 
for the commodity he produces. The increase in 
these prices may be due to causes over which he can- 
not exercise the slightest control, and yet he gains a 
great profit. The illustration of this which leaps to 
the mind is that of the rubber industry. Rubber 
was known before its great uses as an insulating ma- 
terial in the electrical industries were realized, and 
the invention of the pneumatic bicycle and motor 
tire increased the demand and, consequently, the price 
to a tremendous extent. 

Not only industrial, but also social developments 
may cause property, hitherto of slight value, to increase 
in value to such an extent as to make the owner wealthy, 
and this without the slightest exertion on his part. 
The development of a city in one direction instead 
of another causes great inequalities in the value of 
lands which may have been equal before the develop- 
ment. Any great city can provide instances of the 
beginnings of great fortunes through such increases 
in land values. It is true that by an exercise of fore- 
sight certain individuals can purchase property cheaply 
in the belief that some future developments will 
increase its value, but that does not take away the 
accidental nature of the resulting fortune. 



338 AN INTRODUCTION TO ECONOMICS 

2. Opportunity — It is said that opportunity knocks 
at everybody's door. This may be true, but it is 
not everybody who is able to unlock the door. The 
key may be, in the business world at any rate, in the 
possession of the controller of capital. Many oppor- 
tunities are lost not so much for want of recognition 
as of power to take advantage of them. There is a 
well-known story of a man who claimed that he was 
once offered the whole of the site of Chicago for a 
pair of boots. When asked why he did not make the 
exchange, he replied that he did not possess the boots. 
We must, therefore, qualify our meaning of the term 
opportunity, by considering it only as effective oppor- 
tunity. Opportunity is of no value to the jnan who 
cannot take advantage of it. 

The possession or the control of the means to take 
advantage of opportunity may be the result of any of 
the general causes of wealth, but granted its posses- 
sion, the opportunities which become effective consist 
essentially of two kinds. First there are the oppor- 
tunities which arise at the beginning of some new 
industry — the railroads, for instance. We have al- 
ready pointed out in a previous chapter that the flow 
of capital is not steady, but that it moves in a series 
of jerks or leaps. There is always a time in every 
new business when the cautious man waits to see the 
results before he invests his capital. In the mean- 
time the adventurous have seized their opportunity 
and by the start obtained, have sometimes succeeded 
in building great fortunes. Provided one assumes the 
possession of the necessary original capital, the wealth 
resultant from the seizure of opportunity may be 



THE PERSONAL DISTRIBUTION OF WEALTH 339 

considered as due to the foresight of the individuals 
who have recognized and taken advantage of the 
opportunity. To use the slang phrase of the business 
world, there are opportunities of " getting in on the 
ground floor." Most of the businesses in which great 
fortunes have been made are now built many stories 
above the ground floor. To change the metaphor, 
it was easily possible to jump into the train when it 
was just about to start, but now that it is moving 
at sixty miles an hour the chances of getting crushed 
are greater than those of reaching the carriage. Ground 
floor opportunities nowadays are usually based on the 
second of the two main divisions, the possession of 
private knowledge. 

The multitude of ways in which private and exclusive 
knowledge may be the basis of great fortunes cannot 
all be described here. It is notorious, however, 
that in the financial world, many, if not most of the 
great fortunes have been made through the use of 
private and exclusive information. The methods of 
the stock exchange have herein played their part. 
To give a single and common illustration, we may 
point out the advantage which is taken by financiers 
who have information of the increased dividend to 
be paid by some company. They buy the stock of 
the company before the knowledge of the new dividend 
becomes public and when the stock is, therefore, 
undervalued, only to sell when the price rises on the 
declaration of the dividend. 

3. Efficiency — The owners of great wealth almost 
always claim that their wealth is the natural reward 
of their efficiency. A careful analysis of the sources 



340 AN INTRODUCTION TO ECONOMICS 

of great fortunes, however, tends to show that the 
element of efficiency, at least in so far as it concerns 
productive efficiency, does not play too prominent 
a part. Indeed it depends very greatly upon the 
actual definition of efficiency and the direction in 
which the efficiency is applied, which makes for the 
importance of this element as a cause of wealth. Under 
present social and economic organization efficiency 
as a workman will never bring great wealth to the 
workman. There is greater opportunity for the 
efficient organizer, but even that opportunity is 
greatly overestimated. Efficiency in financial manip- 
ulation will tend very strongly to build up a great 
fortune, but that is not the type of efficiency which is 
usually suggested. If it could be shown that in the 
majority of cases the efficient workman, teacher, or 
manager gained great wealth, there might be some 
reason for placing importance on that factor ; but 
one searches in vain among the ranks of the multi- 
millionaires for the one whose industrial or organizing 
efficiency is the sole cause of his great wealth. That 
efficiency plays a part, we cannot doubt, but its part 
is more obvious when we consider the middle groups 
of society rather than the extremes. 

4. Alonopoly — The effect of monopoly as a factor 
in the production of great fortunes is extremely diffi- 
cult to measure, but its importance can hardly be 
overestimated. In this consideration we have the 
advantage of knowing the results of a careful investi- 
gation into the causes of the wealth of some four 
thousand millionaires. The investigation shows that 
" about seventy-eight per cent of the fortunes were 



THE PERSONAL DISTRIBUTION OF WEALTH 341 

derived from permanent monopoly privileges and only 
21.4 per cent from competitive industries unaided by 
natural and artificial monopolies. Yet there can be no 
question that if these 21.4 per cent were fully analyzed 
it would appear that they were not due solely to per- 
sonal ability unaided by these permanent monopoly 
privileges. They were mostly obtained from manu- 
factures, and five sixths of the manufactures of the 
country are based on patents. Besides, fortunate 
investment in real estate, stocks, etc., have often 
contributed to great fortunes where they do not appear 
prominently. Furthermore, if the size of the fortunes 
is taken into account, it will be found that perhaps 
ninety-five per cent of the total values represented 
by these millionaire fortunes is due to those investments 
classed as land values and natural monopolies and to 
competitive industries aided by such monopolies." ^ 

The Causes of Poverty — The causes of poverty 
necessitate a more complicated analysis than those 
of wealth. Much more attention has been paid by 
students of sociology to the study of problems of 
poverty than to the causes and effects of great wealth. 
In the main, however, there are two groups into which 
the various causes of poverty may be separated, and 
different students lay different stress upon one or 
the other. The general consensus of opinion at present, 
however, is that the greater proportion of poverty 
is due to causes closely connected with industrial 
and social maladjustment, and the lesser amount due 
to personal inefficiency and thriftlessness. 

It is, indeed, often argued that a great amount of 

^ Gimmons, The Distribution oj Wealth, p. 252. 



342 AN INTRODUCTION TO ECONOMICS 

poverty is inevitable ; that the fundamental basis 
of human life renders poverty a necessity either in 
the form of a general low level of subsistence or else 
in a peculiarly acute form of poverty suffered by a 
greater or less portion of the population, balanced 
by a relative comfort on the part of the remainder. 

This argument is based on the theory that popula- 
tion tends to increase faster than the production of the 
necessities of life, and hence, unless there is some force 
at work which causes periodically great reductions 
in population, as, for instance, war, pestilence, and 
famine, the total dividend of necessaries will be insuffi- 
cient to provide more than the bare limits of subsistence 
for, at any rate, a large proportion of the population. 

Turning now to the two main categories of social 
and industrial maladjustment and personal inefficiency 
or thriftlessness, we find considerable room for argu- 
ment as to which of the two should include one or 
other of the subsidiary causes of poverty. The pri- 
mary causes of poverty have been well analyzed into 
seven divisions : 1. Old age and sickness, and the 
death of the principal wage earner. 2. Unemploy- 
ment. 3. Irregular employment. 4. Large families. 
5. Low wages. 6. Thriftlessness. 7. Liefficiency. 

It is obvious at once that these divisions are very 
closely interrelated. Unemployment and irregular 
employment are really parts of the same problem, 
but with sufficient differences to make it worth while 
to consider them separately. Inefficiency itself may 
be a cause of low wages, or of irregular employment, 
and yet, from another point of view, may be an effect 
of these. Sickness and premature death, also, may 



THE PERSONAL DISTRIBUTION OF WEALTH 343 

be due to low wages or to thriftlessness. We must 
attempt to decide, as accurately as we can, whether 
to place the ultimate blame for the various forms of 
poverty upon social or industrial maladjustment, or 
upon the shoulders of the individual himself. To do 
this, however, involves a depth of study which cannot 
be attempted here. We may, however, sum up the 
conclusions which are more or less generally accepted 
by recognized students of the problems of poverty. 

It is undoubted that there is a vast amount of 
thriftlessness and inefficiency, but it is also obvious 
that such thriftlessness and inefficiency are not always 
confined to the poor. If wages are so low that they 
suffice merely for the bare necessities of life, thrift 
is impossible without danger of death from starvation 
resulting. Thriftlessness may exist and does exist in 
the wealthy as well as among the poor, but as no 
complaint comes from the wealthy there has been no 
question of the problem of thriftlessness in that class. 
Inefficiency is cominon, also, with the possessors of 
wealth, but as society does not, apparently, have to pay 
for such inefficiency (or idleness which may be classed 
as inefficiency), again there has been no problem to 
discuss. 

In fact all of the faults of the poor can be discovered 
in a greater or less degree among the rich. These 
problems involve psychological, rather than economic, 
considerations. 

Old Age, Sickness, and Death of Chief Wage Earner 
— In at least one very careful estimate of the causes 
of primary poverty over twenty per cent of the pov- 
erty was shown to be due to the age, sickness, or death 



344 AN INTRODUCTION TO ECONOMICS 

of the chief wage earner. The existing remedies for 
the evils due to these causes, as far as the poor are 
concerned, may be divided into three classes — sav- 
ings, private charity, and public assistance. As far 
as savings are concerned, and with these we may 
include such small amount of insurance as is carried, 
it can be readily seen that there is no possibility of 
the amount being very great. The amount earned 
by those who are near to the verge of primary poverty 
is so small that any sum saved is a direct reduction 
of the amount necessary to provide the minimum 
requirements of subsistence. To devote any of the 
earnings to saving may easily mean the step below the 
border line. A week's sickness is often enough to 
cause the border to be crossed. The earnings, as the 
earner grows older, become less and that fact alone 
will cause the development of primary poverty unless 
the children are in a position to assist. It must be 
noted, too, that the life on the margin is such as en- 
courages the growth of disease and predisposes the 
worker to that very sickness which causes his ultimate 
poverty. Again, the death of the chief worker, when 
it is not due to accident more or less intimately con- 
nected with his work, is often the result of lack of 
stamina due to malnutrition. 

Savings are of little assistance. Private charity, 
principally that of neighbors little better off, is a mere 
temporary relief, and the public assistance has often 
been given in a grudging spirit and with all the appear- 
ance of charity — a charity which a large proportion 
of the poor will refuse as long as they are physically 
able. 



THE PERSONAL DISTRIBUTION OF WEALTH 345 

Do these causes of poverty belong to our first cate- 
gory, the maladjustment of industry, or are they due 
to personal inefficiency? It is obvious that they are 
intimately connected with the question of low wages. 
We can, therefore, only answer this question when we 
have considered that of low wages. 

Unemploynieiit and Irregular Employment — The 
amount of primary poverty due to unemployment 
and irregular employment is variously estimated. 
That it forms a very important factor, however, no 
one denies. Irregular employment does not necessarily 
mean poverty. A barrister or a civil engineer often 
works irregularly, but is not reduced to poverty 
thereby. Poverty is the result of irregular employ- 
ment at low wages. Unemployment is merely an 
extension of the question of irregular employment. 
Few workmen are permanently employed, and the 
only essential difference between unemployment and 
irregular employment is the tendency of the former 
to exist for longer periods, which follow on periods 
of comparatively steady work. Both, however, are 
largely due to industrial maladjustment. It is true 
that there exists a class which is called the unemploy- 
able. But whether this class is not the result, itself, of 
industrial maladjustment is a problem worth discuss- 
ing. There is no doubt that, if it is not entirely due to 
poor organization of industry, at least poor organiza- 
tion has a considerable amount to do with it. 

Low Wages — We now come to the consideration 
of the principal cause of poverty, low wages. We 
have already seen that the question of wages is inti- 
mately connected with the other causes of poverty. 



346 AN INTRODUCTION TO ECONOMICS 

An English Justice of the Peace toward the end of the 
eighteenth century made a remark concerning the 
wages paid by cotton manufacturers of Manchester, 
which is still applicable. He said that if the cotton 
manufacture could not be carried on unless starvation 
wages were paid, then the cotton manufacture had 
no right to exist. It has since been proved conclu- 
sively that this industry can be successfully carried 
on even when much higher wages are paid. To make 
a dogmatic assertion of the right of a workman to a 
living wage may seem to be encroaching upon the 
realm of ethics, but the economist cannot always 
make the distinction between his own science and that 
of ethics. Any industry which is impossible without 
the payment of low wages, has no justification. From 
a social point of view, the industry exists to supply 
a social need. If the measure of its social necessity 
is so small that the returns do not justify a wage suflS- 
cient to cover the necessities of life to those who provide 
for the needs, then the industry is not of sufficient 
value to warrant its continuance. 

Low wages are an inevitable source of poor labor 
and discontented laborers. There is an obvious, but 
erroneous argument that labor costs are synonymous 
with wage rates. This idea still exists in spite of 
the thousands of cases where it has been disproved. 
On the one hand we have industrial leaders declaim- 
ing against the competition of foreign pauper labor 
and on the other the same individuals stating that 
the American workman can turn out much better fin- 
ished goods than the foreign workman and several 
times more quickly. It must be realized that high 



THE PERSONAL DISTRIBUTION OF WEALTH 347 

wages almost invariably pay the employer, provided 
his organization is good. This question will be con- 
sidered further in our discussion of labor problems. 

Another effect of low wages is, however, to depress 
the condition of the wage earner to such an extent 
that he cannot be efficient. His inefficiency is often 
directly or indirectly due to his low wages. Naturally 
the low-paid trades only attract those who are either 
unskilled or who have failed at the trade which they 
know, and in so far we may say that ineflSciency en- 
courages low wages. Even if that be true, however, 
it cannot be said that inefficiency causes low wages. 

And now we come to the final cause of poverty — 
the thriftlessness of the poor. To describe thriftless- 
ness as a cause of poverty is to put the cart before the 
horse. Thriftlessness is the inevitable result of poverty, 
particularly of primary poverty. The primary poor 
have no further to fall; they have, as it seems to 
them at least, no chance to rise, and hence their lives 
become an example of fatalism. They live from day 
to day and the present is always with them. It is the 
immediate satisfaction that is required and the future 
is discounted at a heavy rate. It is said that the poor 
waste their substance in drink. Possibly the charge 
is true, and we have no wish to minimize the evils of 
drink. But we must at the same time recognize 
that very often poverty is as much the cause as the 
consequence of drink. 

Sufficient has been said now to show that our main 
conclusion as to the causes of poverty is that poverty 
is due in a preponderating measure to social and in- 
dustrial maladjustment. But we have yet to answer 



348 AN INTRODUCTION TO ECONOMICS 

the question why this maladjustment is allowed to 
remain. We presume the belief that a greater equal- 
ity of income would be a benefit to society as well as 
to the great bulk of the individuals who compose it. 
Why is not the equality attained ? To answer this 
question we must consider the incentives to wealth 
and to work. 

The Incentives to Wealth, i. The Will to Live — 
The fundamental incentive to wealth is the desire 
to escape poverty, which is itself a desire to escape 
death. Talleyrand, the great French statesman, re- 
plied to an applicant for a position who used the old 
phrase, "a man must live," " I don't see the necessity." 
This cynical utterance has been repeated with great 
approval by the would-be witty and by those who are 
themselves in a good position, and who believe in 
the inefficiency theory of the cause of poverty. As 
a. matter of fact, however, the old expression is true. 
A man must live, if he is to continue being a man. 
It is an individual belief and society is composed of 
individuals. Under present conditions, the possession 
of wealth is the guarantee of life. Its lack is the signal 
for death. In a primitive society death was always 
near, but with the growth of industry and the gradual 
building up of modern industrial organization, the 
approach of death has been postponed. But it has 
not been postponed for all alike. Apart from the 
accidents of life and the inevitability of death, its 
approach is still determined by the amount of wealth 
the individual has obtained. Hence the inevitable 
struggle for wealth. It is the will to live made con- 
scious and intellectualized. The primitive savage 



THE PERSONAL DISTRIBUTION OF WEALTH 349 

indulged in no speculations as to why lie sought for 
food, or why he stored up those possessions which 
were of value to him. Nevertheless, the will to live was 
there. All that has changed since that era is the degree 
of intelligence displayed in satisfying the will to live. 
We have based our society on the individual possession 
of wealth, and all, in greater or less degree, still seek 
to gather wealth in order to postpone the evil hour 
when the wealth shall be of no more use. Not only 
for ourselves do we seek the wealth, however. The 
parent seeks to prevent the poverty of his child and 
tries to guarantee security against want by increasing 
his own struggle for wealth. Security against poverty 
is the great stimulus to the search for riches. 

2. The Acquisitive Instinct — But the pursuit of 
wealth is assisted and developed by the acquisitive 
instinct. In some cases the latter persists after the 
security against poverty has been attained. In ex- 
treme cases the result is the production of the miser, but 
there are many degrees. The habit of acquisition 
remains after the original aim has been satisfied, and 
the pursuit of wealth for wealth's sake is the result. 

3. Emulation — While we are safe in considering 
the will to live as the fundamental cause of the pursuit 
of wealth, it is not the only cause. For, the first 
desire being satisfied, others develop. The spirit 
of emulation has a strong influence. We like to do as 
well as our neighbors. In fact we go further ; v/e 
wish to appear more prosperous. Living in a society 
in which wealth is the index to social position, we find 
that the desire for social importance itself produces 
a further incentive to the pursuit of wealth. This is 



350 AN INTRODUCTION TO ECONOMICS 

evidenced in all ranks of society, but nowhere is it 
more strongly developed than in the wealthy classes. 
Here emulation turns to ostentation and extravagance. 
The pursuit has been so successful that the problem 
of the expenditure of the acquired wealth arises. The 
owner of the wealth actually has to devise new desires 
to satisfy, in order to expend what he has acquired. 

4. The Will to Power — Finally, we come to an 
incentive which is almost as important as the will to 
live — the desire for power. It is not given to all 
to have the dominant instinct or the ability to put 
the instinct to effect. There are those who have little 
desire to govern others, but, on the other hand, there 
are many who constantly desire the power to rule 
and to control. Under modern conditions the power 
to control the actions of others lies essentially in the 
hands of those who possess wealth. Wealth is a means 
of power and hence those who strongly wish to exert 
their dominant instinct must first seek wealth. 

Now all these desires are inherent in humanity. 
That they have led to abuses and inequalities is un- 
doubted, but that does not lessen their importance. 
Nor does it necessarily follow that the desires must 
be eliminated before we can secure the removal of 
the evils whose existence we admit. It has been 
argued, however, that those evils are the natural result 
of the desires and that they are, therefore, inevitable. 
But this is by no means true. It is only true if we 
premise a society like the present in which wealth is 
the insignia of power and importance. Now it is 
not true, as has often been supposed, that if the posses- 
sion of undue wealth were not permitted, the stimulus 



THE PERSONAL DISTRIBUTION OF WEALTH 351 

to exertion, whether of hand or brain, would be lost. 
A brief analysis of the incentives to work will serve 
to remove that idea. 

The Incentives to Work — It is true, of course, 
that the incentives to industry sometimes coincide with 
the incentives to wealth. This is particularly so in 
regard to the first of those incentives — the will to 
live. But, having granted that primary similarity, 
we must also admit that work is a human necessity. 
The expression " the right to work " has long been a 
commonplace among working men, but the sense in 
which they use it is that of the right to gain a 
living through work. That is not the sense in which 
we speak of work as a human necessity. The desire 
for activity is elemental, and idleness is only pleasant 
as a relief from activity. Even a schoolboy will tire 
of too long a vacation and it will be a relief to get back 
to the discipline and industry of the schoolroom. We 
overestimate the importance of idleness because we 
have too little -.of it. To the man whose life is a con- 
stant round of more or less uncongenial work, the idle 
period seems like a brief taste of heaven. But even 
those who have the opportunity to be idle constantly 
are nevertheless nearly always seeking for some outlet 
for their energies. It is true that they may find that 
outlet in sport or in some of the more inane activities 
of the idle rich, but not necessarily so. These follies 
may show a lack of intelligence, but they do not show 
that work is distasteful. They are merely an echo 
of the general feeling that work is unpleasant, a feeling 
generated by the fact that most of us have too much 
of it, and a great deal of it is needlessly unpleasant. 



352 AN INTRODUCTION TO ECONOMICS 

"The Joy of Working" ^ Again, much of the 
pleasure of work is lost at present through the fact 
that so much work is poor. There is no pleasure 
in doing poor work, but, on the contrary, there is a 
great delight in doing good work. Compare the 
attitude of the workman in a shoddy furniture factory 
where everything is sacrificed to speed and cheapness, 
with that of the workman who is doing a high-class 
job with the best materials and with sufficient time 
allowed to produce his best work. Listen to the 
conversation of a couple of engineers off duty. Almost 
invariably it will turn on the work they have been 
doing. There is contemptuous scorn for a set of 
badly constructed and erratic engines, but there is also 
the almost paternal pride in a good set. Kipling's 
"McAndrews' Hymn " is not all imagination. The feel- 
ing exists to a greater or less degree in all of us. The 
London bus driver spends his holiday riding on an- 
other man's bus. 

Society has, up to the present, made too little use of 
the spirit which animates the man engaged in good 
work. Too much is sacrificed to a totally unnecessary 
cheapness, and to overexertion on the part of the 
worker. Even the enthusiast will tire if the subject 
of his enthusiasm is too much with him. 

We may be quite sure, then, that even if the incen- 
tives to wealth did not exist, work would go on, and 
very likely much better work through tlie stimulus 
of the pride in the work done, and the joy of working. 

The Creative Instinct — There is a further point 
which must not be omitted, and that is the effect 
of the creative instinct. If there is one form of work- 



I 



THE PERSONAL DISTRIBUTION OF WEALTH 353 



ing which is not influenced by the desire to accumulate 
wealth, it is the creative form. The artist produces 
his pot boilers to earn a living, but his real work, the 
work on which he spends most of his time and all of 
his best efforts, is done in the joy of a new creation, 
an expression of himself which is independent of his 
social or financial position. And by the_ artist, we do 
not necessarily mean only the painter, sculptor, or 
musician. The creative instinct is in all of us to a 
greater or less degree. It is the driving force of the 
inventor, but it is also the stimulus of the craftsman 
no matter what his craft. It is not necessary even 
that the craftsman should produce the whole of the 
finished article. The pride in the working may only 
extend to his particular product, but it is there. 

The Organizing Instinct — The organizing instinct 
is only one aspect of the creative. There are men who 
are born to create order out of chaos and whose special 
pride it is to do so. These are the born organizers 
and it is waste of social material to lose or to abuse 
their powers. There can be little doubt that it is 
not entirely the rewards of the organizer which induce 
him to work. Provided the initial security against 
poverty is attained, then he would do the work of the 
character for which he is best suited rather than not 
work at all, or work at some less congenial but more 
profitable occupation. 

The Dominating Instinct — The same is true of 
the dominating instinct. The men who possess in 
the highest degree the will to power and who have 
the requisite ability to exercise that power will inevit- 
ably secure the controlling positions. At present they 



354 AN INTRODUCTION TO ECONOMICS J 

do so by attaining wealth, since by the possession of 
wealth alone are they able to realize their power. It 
is obvious, however, that many of them have far 
more wealth than they can possibly use and indeed 
sometimes more than they desire, but as power depends 
upon wealth they seek more and more. The present 
situation is unfortunate in that it often gives power 
into the hands of those who have merely the money- 
making gift, which is not by any means the same as 
the creative or organizing power. If the domination of 
those who are not really the possessors of the directive 
and controlling ability were eliminated from society 
by the removal of the wealth stimulus, society would 
be an infinite gainer. 

In this chapter we have tried to show that the great 
inequalities of the personal distribution of wealth are 
not necessary to the continuance of industrial society. 
At present wealth is the one means of satisfying some 
of the strongest of human instincts. There is little 
doubt, however, that these instincts would still be in 
operation were the wealth stimulus removed. The 
feeling that gross inequalities of wealth possession in- 
volving lavish and wasteful expenditure on one hand 
and semistarvation on the other, are a disgrace to civ- 
ilization, is growing. The remedies for the existing 
conditions must remain for discussion in a later chapter. 



CHAPTER XXVI 
THE REMUNERATION OF LABOR 

The Meaning of the Word Labor — Like so many 
other words which are used in common speech, the 
meaning of the word labor varies according to cir- 
cumstances. In the most accurate sense the word 
signifies the human effort in the production of utihties. 
This is a much wider meaning than is commonly given 
to the word labor. In ordinary speech it usually 
means manual effort only. When we speak of a 
laborer we naturally understand a person who works 
with his hands. No one thinks of the general man- 
ager of an insurance company as a laborer ; nor is the 
term usually applied to a consulting engineer or a 
doctor. Yet each of these is using his effort to produce 
utilities. In the distribution of the national dividend 
(i.e., the total amount produced within the nation 
in a definite period of time, say a year) labor must have 
its share as well as capital, rent, interest, and profits. 
The management of a business is just as much labor, 
in the true sense, as the work of the mason and car- 
penter. 

There is a strong tendency nowadays for the manual 
workers to realize their community of interest with 
those who work by brain instead of by hand, but 
nevertheless, there is much justification for the common 
meaning attached to the term. It has been recognized 

355 



356 AN INTRODUCTION TO ECONOMICS 

that the manual worker is at the bottom of the social 
scale as well as of the economic, and the problem of 
keeping him contented — which is the aim of one class, 
or of providing him with an adequate share of the 
world's products and the means of a full development 
of his capacities, has laid such a stress on his particular 
form of labor that it is perfectly natural to restrict 
the term to that form. The fuller meaning, as we 
shall see in a later chapter, is of great importance in 
discussing modern problems, but in the meantime 
we shall consider labor as meaning that form of work 
which deals mainly with physical effort and leave out 
of consideration the purely mental effort. 

Labor's Part in Production — It is customary to 
speak of capital as if it were a separate and almost 
human entity. Capital is, however, merely a form 
of a product. By itself it is not a producer. Capital 
is a tool, and the tool is useless without the hand to 
wield it. The human effort is the prime moving 
force and without this all the capital in the world is 
absolutely useless. At the same time, capital, while it 
is undoubtedly the result of labor, is the result of 
past labor — labor which has been employed in the 
producing of a means to an end. Labor is not exactly 
useless without capital ; it is inefficient. The ineffi- 
ciency, however, at any rate as far as the satisfaction 
of the needs of the modern world is concerned, amounts 
practically to uselessness. 

Without the stored-up labor in capital modern pro- 
duction would be impossible. Now the facts are that 
labor is separated from the ownership of capital. 
This is not necessarily so. Of course a man may own 



THE REMUNERATION OF LABOR 357 

all the tools and machinery which are necessary for 
his own particular occupation. A dentist may, and 
usually does, own his forceps, drills, and other apparatus. 
But there is nothing inherently necessary in labor 
owning its capital. The ownership is usually vested in 
some person or group of persons who do not themselves 
perform the labor which makes use of that capital. 

Hence it is worth while, in practice, to consider the 
actual share in production which is due to labor, 
apart from the share due to capital. 

It is quite impossible to apportion the share due to 
labor in any scientific way. In practice one is just 
as necessary as the other, and in different occupations 
the ratio of capital to labor varies within very wide 
limits. In an industry like the manufacture of cotton 
an enormous amount of capital is required. In simple 
agriculture the proportion of capital (using the term 
principally as applying to fixed capital) is compar- 
atively small. 

Labor as a Commodity — Labor, however, is not 
the inanimate entity that capital is. Labor presup- 
poses the laborer. This fact is of great importance 
in our study. There was a tendency not so very long 
ago to speak of labor in exactly the same terms as we 
speak of steel manufactures or of wheat. It was 
regarded as a commodity that is bought and sold and 
subject to all the laws of exchange which we have 
studied in previous chapters. Hence we still use such 
expressions as labor market, supply and demand for 
labor, and so forth. The laws governing the remu- 
neration of labor have been to a very large extent 
based upon the treatment of labor as if it were a form 



358 AN INTRODUCTION TO ECONOMICS 

of goods. We shall have to examine some of these 
laws, but before we do so, it is necessary to under- 
stand fully that labor cannot be treated exactly as a 
commodity. 

The problem with which we set out, the finding of 
the best means of utilizing the economic resources 
of the world, did not imply that the solution was 
reached when one or two, or even a large group of 
individuals received all that their demands required. 
Rather it meant that all the individuals in the world 
should be satisfied as far as the resources of the earth 
made possible. To treat the laborer, therefore, as 
merely the possessor of a certain quality which is 
necessary to the welfare of his fellows, although inci- 
dentally necessary to himself also, is unsound. It is 
to follow out the Greek idea that culture was the 
prerogative of the wealthy, or at any rate, of those who 
were sufficiently possessed of the world's goods to be 
free from the necessity of working for a living. It 
is to accept Nietzsche's idea that only the favored few 
are capable of the highest development and that all 
others are merely means to the securing of that high- 
est development. In simple words, the laborer, if labor 
is considered to be a commodity, is regarded in exactly 
the same manner as one regards horses and cattle. 

Now while we do not argue that all are capable of 
the same heights of development, nevertheless, we 
assume that each is entitled to the privilege of securing 
the highest development of which he is capable, and 
that the welfare of the race is not determined by the 
attainments of the few, but rather by the high average 
of culture attained by all its members. 



\ 



THE REMUNERATION OF LABOR 359 

Wage Theories, i. The Iron Law — With this 
preface, then, we can now turn to the consideration 
of some of the theories suggested to explain the remu- 
neration of labor. It has been assumed that labor 
is subject to the laws of supply and demand. The 
greater the supply of labor, coupled with a constant 
or decreasing demand, the smaller the share which 
the individual laborer could obtain. Given a certain 
proportion of laborers to a certain demand, it followed 
that there was a definite limit to the average share of 
the product received by the laborers. Let us take 
an example. Suppose there is a demand for fifty 
laborers and a production which warrants a total pay- 
ment to labor of $1000. The amount that each laborer 
can receive is $20. Of course some may receive more 
than this amount, but if they do, others must receive 
less. Now suppose that, without increasing the 
sum available to pay the laborers, that is, without 
increasing the demand for labor, the number of laborers 
is increased to one hundred. Obviously the amount 
which each can receive on the average is only $10. 

On the other hand, should the demand for laborers 
increase and the number remain constant, the indi- 
vidual laborer's share would increase. Things remain 
the same when the demand for labor keeps pace with 
the supply. The question then arises, what is the 
cause of the demand for labor. Labor in itself is 
not desired — it is merely a means to an end. It is 
the product of labor which is required. But the product 
of labor is limited by the earth's resources, coupled 
with our knowledge of the means to make use of them. 
The supply of labor is determined largely by the increase 



360 AN INTRODUCTION TO ECONOMICS 

or decrease of the population. At the time in which 
the theory we are now discussing was most strongly 
held, the food production of the world was working 
under the law of decreasing returns. Population, 
however, tended to increase at a faster rate than food 
production. Hence a time arrived when the means of 
feeding the increased population was insufficient for 
its needs. Some must starve. The starving, however, 
would struggle to obtain as much as possible, and 
would offer themselves for wages which would suffice 
to keep body and soul together. The tendency, 
th(^refore, was to force the wages down to the bottom 
level of subsistence. If the laborer received less than 
sufficient to feed him, he died and so starvation reduced 
the population down to the level at which there was 
sufficient food to go around, but only sufficient. 

Any improvement in the means of obtaining an 
increased supply of food was, it was assumed, immedi- 
ately followed by an increase in the population. Hence 
wages tended to fall, by this very pressure of popu- 
lation on the means of subsistence, to the level at 
which subsistence was just possible. 

We have stated this argument as if it actually 
represented the facts. At the beginning of the nine- 
teenth century, in England, at any rate, where the 
theory was developed, the facts did seem to justify 
the conclusion. But before the century was far 
advanced, the facts changed. Wages were not forced 
to the level of subsistence. The " iron law," as it has 
been called, was broken, and therefore, invalid. 

The theory was not quite abandoned, however. 
It was mitigated by changing the term level of sub- 



THE REMUNERATION OF LABOR 361 

sistence to the words standard of living. The new law 
was expressed somewhat as follows. Wages tend to 
fall to the level which will provide for the subsistence 
of the laborer at the standard of living to which he 
is accustomed. As a Socialist writer put it, " If the 
working man believes that bottled beer and chops 
are necessary for subsistence, his wages will be suffi- 
cient to provide him with bottled beer and chops." 

This, however, did not affect the principle of the 
argument. All that was changed was the meaning 
given to level of subsistence. Under this theory, 
wages are still dependent upon population. From 
the logic of the argument there is no escape. If we 
admit the premises, we must accept the conclusion. 
But are the premises correct .^^ It would seem from 
experience that they are not. In the first place, 
when the theory was first formulated, the conditions 
of the time lent a strong color to the argument by 
which it was supported. The population was increas- 
ing by leaps and bounds. At the same time the pro- 
duction of food was, although increasing, increasing 
at a much slower rate. There was no suggestion 
that the old countries could draw to such an amazing 
extent as is now the case, on the New World for their 
food supplies. Hence it appeared as if the facts actually 
justified the theory. But as the New World began to 
be drawn upon for food supplies — as the prairies 
of America were gradually and increasingly cultivated, 
and as the facilities for sea transportation improved, 
the food difficulty seemed to be solved. Nor has 
population increased to the extent that was anticipated. 
There seems to be a strong tendency for the increase 



362 AN INTRODUCTION TO ECONOMICS 

of population to be less under prosperity of the indi- 
vidual rather than greater. The larger families are 
seen in the poorer portions of the population, not in 
the more well-to-do. 

The theory must, therefore, be abandoned. We 
know that there is sufficient knowledge of the earth's 
resources, and sufficient resources to feed adequately 
all the population of the world. The problem is 
rather to discover how the knowledge may be made 
use of to the best advantage, and how the product 
may be more equitably distributed. Labor has come 
to demand something more than a mere subsistence 
wage. It demands the " living wage," and the inter- 
pretation of the word living is becoming more generous 
with each advance in the general standard. The 
modern demand of the laborer is that he should have 
sufficient share of the productions of the world to 
develop himself to the fullest extent ; that his labor 
should not fill all the hours of waking, but that he 
should have sufficient leisure to make life worth living. 
This demand is a worthy one. Can it be met ? That 
is a problem which must be discussed in a later chap- 
ter. Meanwhile we must turn to another aspect of 
the problem of the remuneration of labor. 

Money and Real Wages — It is a commonplace 
to say that the amount of money a man earns is no 
satisfactory indication of the remuneration of his 
toil. It may quite easily happen that wages tend 
to increase steadily as far as money amounts are 
concerned, but that the recipients become just as 
steadily worse off. Suppose, for example, that a man 
ea;rns $100 a month. It would appear that a rise of 



THE REMUNERATION OF LABOR 363 

$10 a month would improve his position exactly ten 
per cent. But suppose that, at the same time prices 
advance twenty per cent. In this case the $110 at 
the new price buys only about ninety-two per cent of 
the goods that the $100 bought at the old price. The 
wages of the workmen have therefore actually fallen in 
value, although nominally they have risen. 

As we have said, this is a commonplace, but it is just 
one of those commonplaces which are easily over- 
looked. We become so accustomed to dealing in 
terms of money that we are inclined to overlook the 
fluctuations in the value of money. In any discussion 
of increases and decreases in wages, we must be care- 
ful to think of real wages, that is, the purchasing power 
of the wages, rather than the sum of money received 
in a certain time. To make the matter plainer still, 
let us suppose that a man is in receipt of sufficient 
wages to purchase all he requires but not sufficient 
to save anything. Now suppose his wages are in- 
creased, in terms of money, ten per cent. If prices 
remain stationary he should be able, without in- 
creasing his expenditure, to save that ten per cent 
increase. Should prices have risen, however, to such 
an extent that he cannot save at all, but can just 
maintain his old habit of life, neither increasing the 
amount of goods he purchases nor decreasing them, 
then it is obvious that he is in reality only earn- 
ing as much as before. And should he be forced, by 
the rise of prices, to give up some of the things he 
used to buy, his actual, or real wages have fallen, 
in spite of the fact that he receives ten per cent more 
money. 



364 AN INTRODUCTION TO ECONOMICS 

The Method of Pa3mient — Of almost as much 
importance to the wage earner as the amount of his 
earnings is the manner in which he is paid. We may 
distinguish four different methods. 

I . Time Wages — The commonest form of all 
wage payments is the payment by time. All salaried 
workers are paid not according to how much they do, 
but according to the time they spend in doing it. 
If two bookkeepers are paid a salary of $150 a month 
each, no estimate of the amount of ledger work, post- 
ing, and checking is considered in making the pay- 
ments. It is assumed that each is doing the normal 
amount of which he is capable. If he does not do so, 
in all probability he will soon be seeking another job. 
Of the two one may be a much quicker man than the 
other. This does not affect his wages. He is paid 
so much for a month of his effort. 

Again a workman is paid sixty cents an hour for his 
work. Two workmen at the same rate of pay may 
produce totally different amounts of finished work. 
One may be twice as quick as the other and if he be as 
accurate, he is producing twice the amount for the 
same number of cents. In time payments, a certain 
average of work is presumed, and the rate of pay is 
determined largely according to the standard of liv- 
ing. That is to say, if the general standard of living 
for a particular class of workman requires an expendi- 
ture of say, $100 a month, the time wages will be 
such as, on the whole, to provide an income of $100 
a month to the workman. Now in all the group 
earning this time rate, there will be variations be-^ 
tween extreme efficiency and extreme inefficiency. 



THE REMUNERATION OF LABOR 365 

Tlie great bulk, however, will tend to average their 
production. 

There is little stimulus to great exertion in a time 
rate. Nevertheless there are great advantages in 
this kind of payment. In the first place, for many 
kinds of work it is impossible to pay in any other man- 
ner. Take, for instance, the bulk of clerical work. 
There would be a very great difficulty in paying 
stenographers on any other basis than time rates. 
A business man must have his stenographer there all 
the time. At times she will be busy, at other times 
idle. The number of letters written one day will not 
be the same another, and so on. The employer de- 
mands a certain amount of effort. If he thinks that 
his staff has too many idle periods, he decreases the 
staff, so that, on the average, each does a day's work. 

Again suppose it were suggested to pay laborers so 
much a cubic foot of earth removed in an excavation. 
Some workmen might do all their work in soft earth, 
and so be able to remove many cubic feet. Others, 
with an equal expenditure of effort, working in hard 
or rocky ground, would not be able to do nearly so 
well. Now as it is quite possible that the strata 
through which the laborers are digging vary with every 
foot they dig, it is impossible to pay them on any 
other basis than a rate for a period of time, and it will 
be the duty of the foreman to see that each exercises 
his fair share of effort. 

2. Piece Wages — Another method is to pay, not 
according to the time spent, but according to the 
amount produced. There are many industries in 
which this is the usual method. Take the potteries. 



366 AN INTRODUCTION TO ECONOMICS 

for instance. Here there is a long schedule of prices 
to be paid workmen for performing certain pieces 
of work. So many cents a plate of a certain size, 
or a cup or dish, or whatever they may be producing. 
Riveters in shipyards are sometimes paid so much 
a rivet driven, and again sometimes so many cents 
an hour. 

The piece-rate method has the advantage of allow- 
ing the highly skilled or unusually energetic the power 
to reap the advantage of their skill or energy in the 
shape of greater earnings. On the other hand, the 
weaker or less skillful receive less. It is objected, 
however, that rates tend to be decided upon the work 
done by the men of highest skill. The earnings of 
a highly skilled man, coupled with the average amount 
necessary to maintain him in the standard of life to 
which he is accustomed, form the basis of the piece 
rate. As the highly skilled are the minority, the ma- 
jority must either work longer hours, or else suffer 
in decreased earnings. 

It is sometimes found, upon the introduction of 
piece rates, that the production is very much greater 
than was the case when time wages were paid. Hence 
the actual amounts received by the workmen become 
much greater than formerly. Whenever this is the 
case, it almost invariably occurs that there is a cut 
in the rates. The cut tends to bring wages back to 
the amount earned under the time-rate system. This 
is partly the reason why many trade unions object to 
the introduction of piece payments. They claim that 
all that happens is an increase in the amount of work 
done, without a corresponding increase in the pay. 



THE REMUNERATION OF LABOR 367 

On the other hand, it sometimes occurs that the men 
protest against the introduction of time rates. Here 
it is claimed that by speeding-up machinery, the work- 
man produces more work, but reaps no benefit from 
his increased production. 

It is claimed on the whole for piece rates that they 
tend to increase production. Against them it is 
argued that the workman is liable to undue pressure 
in order to earn the wage which he regards as necessary. 
The time wage is blamed for keeping production 
at a minimum, while those who favor it often say 
that it prevents the average man from being imposed 
upon. 

The truth is that it is impossible to say that either 
is bad or good in itself. The case of each individual 
occupation must be settled by itself. 

3. The Bonus Systems — Many attempts have been 
made to combine the two systems so as to get the best 
out of each and to eliminate the evils of both. One 
system is to pay all men, no matter how much their 
production, a standard rate. By an investigation 
into the average time taken in the past for a particular 
job, however, a standard time for a piece of work is 
set. Any workman who passes that standard receives 
an extra payment in the form of a bonus for his increased 
production. In this way, both time and piece rates 
are combined. There is an infinite variety of bonus 
systems, however, and that indicated here is merely 
one of the simplest. It is worth while, however, to 
outline one of the schemes which has been criticized 
very severely and also highly praised. In this system, 
instead of merely averaging from past experience to 



368 AN INTRODUCTION TO ECONOMICS 

find the time in which a job ought to be done, a careful 
scientific investigation is carried out to see which is 
the best way to do it. The best arrangement of the 
machinery is first considered. Then a skilled work- 
man is set to perform the task, every movement he 
makes being noted, and the time taken recorded. By 
a study of his actual movements all waste motions are 
seen. These are eHminated and the workman again 
set to perform the task. When it is seen that every 
motion is essential, and there is no waste, the final 
time is recorded. 

As it is obvious that the time taken by a skilled 
workman under these conditions is hardly the same as 
the time taken b}^ the average man, a deduction is 
made from the amount of production required in the 
standard time, say twenty per cent, or even, in some 
cases, fifty per cent. The time thus arrived at is 
the standard for this job. Then each workman is 
taught the method of production arrived at by this 
investigation. He is paid on a time basis as a mini- 
mum, but he receives a bonus when he reaches the 
standard time, and another bonus when he passes it. 

There is no doubt as to the success of this system 
from the point of view of production. There have 
been most wonderful increases made by its means. 
The effect upon the workman, however, is not so 
satisfactory. There is good reason to believe that 
the increased work is not obtained without a certain 
increase in the effort. The workman becomes rather 
a wonderful machine than a human being. If the 
hours of labor are appreciably shortened so as to offset 
the greater intensity of effort, no harm may be done. 



THE REMUNERATION OF LABOR 369 

but if the system is adopted without change in the 
hours worked, there can be Httle doubt that a great 
deal of harm is done. 

4. Profit Sharing — The final method of payment 
is to supplement the wages by allowing the workers 
a share in the profits. This method, however, will 
require more discussion than we can give space to in 
the present chapter. It will be dealt with later on 
and is here only mentioned in order to complete the 
account of methods of wage payment. 



CHAPTER XXVII 

THE ORGANIZATION OF LABOR 

The Origin of Labor Organizations — There is a 
common but erroneous behef that trade unions have 
their origin in the old trade gilds or craft gilds. This 
is not the case. The craft gild was an organization 
quite distinct in its aim from the trade union. It was 
designed to include every one in the industry, whether 
craft-master, journeyman, or apprentice ; it regarded 
the craft as a unity. The trade union, on the other 
hand, is an organization definitely based upon the belief 
that the journeymen, the common workers, cannot 
protect themselves against the employers unless they 
act as a body. The origin of modern labor organiza- 
tion lies in the realization of an antagonism between 
the laborer and the capitalist. Although we can 
trace the beginnings of trade unionism to periods much 
earlier than the end of the eighteenth century, it was 
the conditions resultant from the chaos of the industrial 
revolution which brought about the great combina- 
tions that have grown to be of such importance at 
the present day. 

The theory of laissez faire which, in the early part 
of the nineteenth century, held full sway, emphasized 
the value of individual liberty. The conception of 
individual liberty, however, did not take into account 
the fact that mere permission to do a thing is not the 

370 



THE ORGANIZATION OF LABOR. 371 

same as granting power to do it. Theoretically, under 
the laws which were so well thought of by the early 
individualists, any man had the right to engage in any 
industry he pleased, conduct that industry as he 
pleased, pay his workmen what he pleased, and so forth. 
At the same time any one also had the right to change 
his employment when he wished, to bargain for higher 
wages, to refuse to work for less than a certain sum, and 
to go where he pleased in search of work. In practice, 
however, this liberty was illusory. The owner of 
capital was in the better position almost invariably. 
What was the use of the workman exercising his right 
to change his employment, when the change could not 
result in an improvement ^ In case he refused to work 
for less than a certain w:age, he was powerless to en- 
force the payment of that wage. 

The much praised freedom of competition of laborer 
with laborer tended inevitably toward the forcing of 
the wages of the laborer and the conditions of his 
labor to the lowest level. 

We have not the space in the present discussion to 
give any account of the evils which unrestricted com- 
petition of laborer with laborer and manufacturer 
with manufacturer led to. As an illustration, however, 
it may be mentioned that in the early years of the 
nineteenth century in England medical testimony was 
called and gravely discussed to prove whether it was 
unhealthy for a child of eight or ten to work for four- 
teen hours a day. 

The fact was that laborers could not hope to im- 
prove their condition by individual bargaining, rely- 
ing upon the generosity of their employers to see that 



372 AN INTRODUCTION TO ECONOMICS 



I 



they received sufficient to keep them and their famihes 
from starvation. There were two alternatives. Either 
the laborers were to become mere serfs, cared for by 
their masters in the same way that cattle and horses 
are cared for, or else they must combine and add to 
their bargaining strength by union. 

The early attempts at union were most bitterly 
fought. Every weapon that could be suggested was 
used against the unions. A parliament elected on a 
restricted franchise, corrupt, and biased against all 
industrial agitations, fearful of outbreaks or revolu- 
tions, passed law after law prohibiting this, that, and 
the other group of workmen from combining to secure 
increases in wages. 

Not content with passing individual laws at the 
solicitation of manufacturers in certain industries, 
these laws were codified into a solid group affecting 
all workmen, no matter what trade they carried on. 
The common law was invoked to render workmen 
liable to be sentenced for conspiracies in restraint of 
trade. 

Out of this chaos of trade which tacitly permitted 
employers to combine, but persecuted labor combina- 
tions, was born the struggle to obtain legal recogni- 
tion of the right to organize. 

The Right to Organize — It is worth our while to 
consider the importance of this right on the part of 
labor to organize itself. We have already seen that 
the tendency of all our modern industrial development 
is toward the elimination of competition. This is so 
in the case of labor, as in most other cases. The 
individual laborer who comes to an employer asking 



THE ORGANIZATION OF LABOR 373 

for a job is, as a general rule, in a poor situation to 
bargain for his wages. He must take what is offered. 
It is only when he is backed by an organization that 
he can insist on a minimum wage and definite standards 
of treatment. 

The right to organize implies the right to do collec- 
tively what is permitted to be done by the individual. 
Any individual may, if he wishes, refuse to work for 
any other individual. If John Jones does not like to 
work for Tom Smith, he does not need to, and it does 
not make any difference if Tom Smith happens to be 
Thomas Smith and Company, Inc. This individual 
right was acknowledged in the laissez faire period. 
But what was right in the individual became wrong 
in the association. The association is powerless, 
however, unless it is granted the right to make use of 
its collective importance. It makes very little dif-^ 
ference to Thomas Smith and Company, if John Jones 
resigns. But it makes a very great difference if 
John Jones is accompanied by all of his fellow work- 
men. In other words, when it comes to a trial of 
strength, the association has a power which is not 
possessed by the individual. The right to strike, 
therefore, is essential to the organization of workmen, 
unless there are other and more satisfactory methods 
of gaining improvements in wages and conditions of 
labor. 

This involves, of course, the right of the employers 
to organize as well. But no one has ever questioned 
this right; it has been taken for granted. The point 
we wish to emphasize is this ; if it is assumed that 
conditions of industry are to be governed by the 



374 AN INTRODUCTION TO ECONOMICS 

bargain made between the employers and the work- 
men, it is only fair that the parties should be in nearly 
equal positions in settling the bargain. To give either 
party an invariably preponderant power is bound to 
result in oppression of the other. 

We are now in a position to define the meaning of 
trade union. We shall find, however, on further ex- 
amination that the varieties of trade unions make it 
necessary to give subdivisions which must be further 
defined. As a general statement, we may say a trade 
union is an organization of workmen which has for 
its primary object the obtaining of increases in wages 
and the improvement of conditions of labor. 

The Methods of Organization — Experiments with- 
out number have been made in the organization of 
trade unions. Hardly any scheme which has been 
suggested for the conduct and improvement of demo- 
cratic government has not been tried. It is difficult 
to say that any particular trade union is typical. 
There are, however, two distinct and broad types which 
are worthy of consideration in the present brief dis- 
cussion. 

There is, first, the craft union. In this case the work- 
men are associated with one another by similarity of 
work. The carpenters form a group of their own, 
each knowing exactly what difficulties occur in the 
carpenter's work, the conditions which should be im- 
proved, and so forth. The bricklayers form another 
union, which is concerned purely with the work of 
bricklayers. It is in this sort of union, which is con- 
fined to the members of a particular craft, that the 
similarity is seen between the trade union and the 



THE ORGANIZATION OF LABOR 375 

craft gild. The difference is obvious, however. The 
trade union is definitely an organization of employees, 
as distinguished from employers ; the craft gild in- 
cluded both. As the association grows in size, the 
trade union tends to affiliate with similar organiza- 
tions in different places. But it is important to re- 
member that it affiliates with organizations in the 
same trade. The machinists union of one city affili- 
ates with the machinists union in another. There is 
no suggestion of an association of painters and black- 
smiths. The trade lines are kept distinct. 

National Association — As it comes to be realized that 
national associations are of great value, in other words, 
as the organization becomes nation-wide in its scope, 
the dependence of one trade upon another is more 
strongly realized. At the time of writing, for instance, 
a strike of a certain number of boiler makers and 
machinists, the actual number of strikers numbering 
perhaps two or three thousand, has caused the idleness 
of over thirty thousand workmen. In order to pro- 
duce common action, some central organization asso- 
ciated with all grades is required, so that all industrial 
workers shall not be at the mercy of a small group, 
and at the same time the small group in what is deemed 
a right cause shall have the support of the whole. 
This association is formed on the principle of a federa- 
tion. Each trade union is autonomous as far as its 
peculiar affairs are concerned. But each is compelled 
in matters affecting all to submit to the orders of the 
central council. 

The national organization becomes a federation of self- 
governing unions, each with its own national council. 



376 AN INTRODUCTION TO ECONOMICS 

The tendency is all the time toward centralization. 
Perhaps the best analogy is that of the government of 
the United States itself. Here we have a series of 
forty-eight states each with its own central organiza- 
tion, in the form of legislative assemblies with their 
officials and executive staffs. All purely local matters, 
that is, all matters that have to do with those within 
the state alone, are settled according to the will of the 
central organization. But all matters tiiat have to do 
with inter-state affairs are settled by an organization 
controlling the action of the states — the Federal 
Government. 

The difference between the government of the 
states and of the country on the one hand, and the 
government of the trade unions on the other, is largely 
due to the restriction of the number of individuals 
within the country and within the trade unions. 
The trade unions that have this federal organization 
include among their members only the workers in the 
organized crafts. 

The American Federation of Labor, which is the 
great central organization of labor in this country, is, 
however, not entirely representative of labor through- 
out the country. It represents rather a class of labor 
— the skilled trades. It has very little to do with the 
great mass of unskilled laborers. There is, it is true, 
a tendency at present to widen its scope to include 
laborers without a trade, but even in so doing, it 
desires to allot these laborers to the trades toward 
which they incline. 

Essentially, the American Federation of Labor be- 
lieves in trade unions rather than in a trades union. 



THE ORGANIZATION OF LABOR 377 

The distinction is of great importance, for it emphasizes 
the tendency which is becoming stronger every day, 
to change toward an organization of labor which ignores 
the difference in trades. Industrial unionism, as it is 
called, believes in the fundamental solidarity of labor. 
All workmen, according to its creed, have the same 
difficulties to contend with, and only by combining as 
a whole can they achieve the solution of their diffi- 
culties. In the industrial union, or as it was known in 
English labor history, the trades union, the ujiit is a 
geographical one, rather than a craft unit. The large 
geographical units are split into smaller geographical 
units until we arrive at last at the fundamental unit, 
the shop. 

There are distinct advantages claimed for this basis 
of organization. In the first place, the men who are 
at work in a single shop or plant know best the condi- 
tions which affect themselves. They know that the 
strike of one particular trade in the shop may bring 
about the idleness of all the workers in that shop. 
Hence it appears that an organization which includes 
all the workers will have a better chance to arrive 
at a proper decision worthy of the action of all com- 
bined, than when one group, for a reason affecting only 
that group, drags all into the struggle. 

Again, when all the workers are united into a single 
union, there is better chance for a truly united action, 
and therefore a successful action, than when the 
trades are separately organized, with the unskilled 
workers unorganized. There will be no possibility of 
jealousy in regard to the trade divisions. With craft 
unions there is always a tendency for the division be- 



378 AN INTRODUCTION TO ECONOMICS 

tween crafts to become vague and indistinct. In the 
engineering trades, for example, there are pattern- 
makers, whose work bears a strong similarity to that of 
carpenters. Yet the unions are separate. In some 
cases, these differences which seem so slight lead to 
awkward complications, each union claiming that the 
other is encroaching upon work which rightly belongs 
to the claimant. 

The industrial union, it is also claimed, leads to a 
feeling of community of interest which is of great value 
in the struggle between labor and capital. 

The chief exponent of the industrial union in 
America is the association known as the Industrial 
Workers of the World, or, more briefly, the I. W. W. 
While the I. W. W. represents the " industrial " attitude, 
as distinguished from the " craft " idea, however, it 
has political and social aims which are extraneous to 
the present discussion. 

The Shop Steward Movement — The final matter 
which must be dealt with under the consideration of 
the organization of labor is the rise of a new and very 
important union officer, the shop steward. The shop 
steward movement represents the tendency to break 
away from the craft union and to develop the industrial 
union. Even in the craft unions it has often been felt 
that the central control exercised by the national 
organization of the craft, has been too far separated 
from the conditions in any particular plant. Some one 
closely connected with the actual daily work in the 
plant, familiar with everything that is going on, it 
was thought, should represent the workers within that 
plant. An individual has been appointed, not rep- 



THE ORGANIZATION OF LABOR 379 

resenting any particular union in the plant, but rather 
representing all unions. His duty is to watch for 
attempts at increasing the hardship of the laborers, 
whatever their occupation, and to represent the united 
employees in disputes within the plant. 

With the advent of the shop steward, it becomes 
evident that there is a tendency to break away from 
the central control. This tendency is seen with in- 
creasing frequency in the labor disputes that occur at 
the time of writing. Local unions refuse to abide by 
the decision of their national organization, claiming, 
often, that the national oflScials are out of touch with 
the actual conditions in the locality. As to the outlook 
for future development we shall say nothing here, but 
consider this matter under another head later on. 

Aims of Labor Organizations — Labor organization 
is only a means toward an end, not an end in itself. 
The question now arises, what are the aims which the 
organized laborers seek to attain? They may be 
summed up in a very few words — the betterment 
of the laboring classes. It will be well, however, to 
divide these aims into four groups. 

1. Collective Bargaining — The original cause which 
drove laborers to organize was the fact that the in- 
dividual was powerless to bargain for good conditions 
of labor. As an individual he was unimportant, so long 
as there was an abundance of labor. In order to obtain 
good conditions of labor, the effect of an abundance of 
labor in the market must be removed. The only way 
to do this was to increase the size of the bargaining unit. 
It meant nothing to an employer if one workman asked 
for an increase in wages or a reduction in the hours of 



380 AN INTRODUCTION TO ECONOMICS 

work ; he could always get another to do the work 
at the old rate. But it was a very different matter 
when a large body demanded a change. It was not 
so easy to replace, at a moment's notice, half of his 
workmen. Hence if the bargaining for improved con- 
ditions was done by a large group, instead of by the 
individual members of that group, the chances of success 
on the part of the laborers were materially improved. 
One of the fundamental aims of all organized labor, 
therefore, has always been that bargains for the change 
of conditions of labor should be made collectively. 
An increase in wages or a reduction in hours should 
affect all of the workers and not one individual. It is 
true that this meant, possibly, a reduction in wages 
for a particularly strong or particularly skilled laborer, 
and an increase for a comparatively inefBcient work- 
man, but on the whole it meant that a decent wage 
would be secured by all. The trade unions have al- 
ways claimed that the rate set for payment of wages 
by individual bargaining has tended to be decided by 
what the poorest would take, rather than what each 
earned, so that payment on the basis of average work 
meant an improvement to all. 

2. Standard Wage — We have already seen in a 
previous chapter that the greatest cause of poverty is 
low wages. After the principle of collective bargaining 
has been secured by the labor unions, the next step, 
and by far the most important, is the securing of better 
wages. No matter on what philosophy the demand 
be based, and many reasons are given for every effort 
at gaining greater remuneration, the fundamental 
fact is that each workman believes that his lot would be 



THE ORGANIZATION OF LABOR 381 

improved by an increase in his wages. Wages represent 
to him the satisfaction of his desires. When his desires 
outstrip the possibihty of satisfying them, he demands 
higher wages. This appears to be a state of affairs 
which can never be improved. As the wages advance 
so do the desires. This is not necessarily an evil. If 
we remember the problem with which we set out, we 
must recognize that the advance of civilization depends 
largely upon the increase in the desires of mankind, 
coupled with the means of satisfying those desires. 

The labor unions believe that a greater share of the 
results of industry should belong to the workers — 
using the word in its limited meaning. Hence their 
demand that wages be increased seems perfectly 
reasonable. Of course labor has recognized the differ- 
ence between money wages and real wages. In all 
modern efforts at increase of wages, a strong point is 
made of the increase in the cost of living. Constant 
studies are made of the variation in the purchasing 
power of money. Before the war it was estimated by 
the United States Bureau of Labor that $800 was neces- 
sary to support a working-class family for a year. The 
latest estimate is somewhat over $1700. If, therefore, 
wages have doubled, the workman has not gained, but 
lost slightly. Yet the unions have had to make bitter 
fights to keep wages rising to meet the cost of living. 

The basis of the union philosophy is that the workman 
should, not be considered as a commodity, but as a man 
and as a citizen. Hence his welfare is as important 
as that of any member of the community. 

3. Conditions of Labor — Arising out of that philos- 
ophy, the unions have demanded that the conditions 



382 AN INTRODUCTION TO ECONOMICS 

under which a workman has to perform his daily 
task should be congenial. Good sanitary workshops, 
safety against dangerous machinery, and so forth, are 
all of importance. Hence the unions have striven, by 
collective bargaining, and by a certain amount of 
pressure upon legislatures, to secure improvement in 
these conditions. The justice of this demand has long 
been recognized and state after state in this country 
has passed factory laws which have for their aim the 
protection of the workmen against conditions of labor 
which were detrimental to their welfare, and thus 
demoralizing to the community. 

4. Hours of Labor — It is curious to note, in the 
history of labor organization, the gradual steps which 
have been taken toward securing shorter hours of labor. 
At first hours of labor seemed somewhat unimportant. 
No one thought, or seemed to think, that part of the day 
should be used for the purpose of leisure or amusement. 
Defoe paints what he considered a beautiful picture 
of the labor of his times — the busy housewife working 
at her spinning wheel, the husband weaving or tending 
to the work of the small farm, the children, even the 
very youngest, engaged in carding wool or assisting 
with the work in many ways. Possibly it was a relic 
of the puritanical objection to all amusement and 
idleness. At any rate the common feeling was that 
those who gave every minute of their waking life to 
work were doing what was right and proper. 

Hours of labor prolonged unduly, however, were 
bound sooner or later to arouse objections on the part 
of the workers. Sixteen hours a day used to be 
considered as almost reasonable. Then there arose 



THE ORGANIZATION OF LABOR 383 

the cry for a fourteen- and a twelve-hour day. A long 
and bitter struggle was waged in England to secure the 
ten-hour day. At present it is generally assumed 
that eight hours represents a fair day's work, al- 
though far too many work for much longer periods. 
There is an agitation going on, headed, it may be noted, 
not by a workman but by an employer of labor, for a 
reduction to six hours a day. 

It has been urged against the working class that this 
constant demand for a reduction of the hours of labor 
is an indication of congenital laziness. We are all, 
however, more or less lazy. That only means that 
we do not want to be doing the same action for too 
long a space of time. Work in itself, as has already 
been pointed out, is not the aim of life. It is a means 
to an end and the end is the attainment of our highest 
development. Work which does not lead to such 
development is not to be encouraged. Of course a 
certain amount of drudgery is to be expected, but that 
amount should be curtailed to the greatest possible 
extent. Labor-saving machinery has been invented 
for the purpose of allowing greater production with less 
effort. To attempt to increase production by the use 
of such inventions without reducing the actual amount 
of work performed is to remove the blessing from the 
discoveries. The workman feels more and more, as 
time passes, that there is more to life than merely 
working. He demands that he be able to secure a 
livelihood without working all the time, so that he 
can use part of the day to enjoy as he pleases. 

The demand made by the labor unions for the 
abolition of overtime is due to a twofold reason. 



384 AN INTRODUCTION TO ECONOMICS 

Partly it is urged as a cure, or at least a palliative for 
unemployment, but also for the reason that leisure is a 
rightful demand in itself. Now in both of these claims 
there cannot be the slightest doubt that the unions are 
right. A certain amount of work is good for a man, 
but too much is as bad as none at all. It is true that 
some find their recreation in work itself. These, 
however, are the minority. There is no value either, in 
the argument that the laborers would abuse their 
leisure. 

When the demand is made for the limitation of child 
labor it is unanswerable. The amount of child labor 
which exists at the present time is a disgrace to civili- 
zation. It can at least be argued that the adult may 
refuse to work if he pleases (the argument is not sound), 
but the child cannot. To force him to work at an age 
when he should be playing is one of the gravest blots 
on our modern society. 

Trade Union Methods — The trade union is, espe- 
cially in this country, a fighting organization. It is 
based on the belief that the battle is to the strong, and 
it endeavors to increase its strength in order to gain 
the victory. The great weapon which organized labor 
possesses is the right to strike. A strike is a con- 
certed refusal to work by a group of employees, with 
the purpose of securing redress of grievances. It is 
tacitly understood that the hiring of labor is a bargain 
between the employer and the employee. The em- 
ployee therefore reserves to himself the right to refuse 
to perform his side of the bargain unless the conditions 
of the contract are to his liking. As we have said, 
when the bargain was between individual laborer and 



THE ORGANIZATION OF LABOR 385 

individual employer all the strength lay on one side. 
In order to equate the strength of the parties, the refusal 
to work must be made by all, or at least a large pro- 
portion of the workers at one time. 

Such trials of strength are not things to be desired. 
Strikes are a form of warfare, and warfare is always 
wasteful. The strike, however, is the last resort, the 
final weapon in the hands of the laborer. It is indeed 
true that often he has been inclined to resort to his 
final weapon before using milder methods. That, 
however, is incidental to a certain stage of development. 
Our forefathers used to settle their private disputes by 
means of duels. Nowadays we resort to legal settle- 
ments. In the early days of the mining industries 
and in the cattle countries, the bowie loiife and the 
revolver settled all disputes. We have outgrown that 
stage now. The same is true of the war between 
capitalist and laborer. We have not, certainly, got 
rid entirely of what we may call the revolver stage of 
settlement, but we are getting rid of it. It is better 
ordered and controlled than it used to be. 

In every method used by the trade union, there is a 
counterpart in the methods adopted by the employers. 
The strike of the workmen is replied to by the lockout 
of the employers. A lockout is the simultaneous dis- 
charge of all workmen or a large proportion of them, 
from a certain industry or a certain plant, in order to 
force them to agree to terms laid down by the employers. 
Here again, we have the other side of the revolver 
argument. 

Now just as it was true in the early days in the 
cattle country that the revolver was necessary because 



386 AN INTRODUCTION TO ECONOMICS 

the law did not exist, so it is true that the strike and 
lockout, as a trial of strength between the parties, are 
necessary now because there is no law. By law, of 
course, we mean definite order for the securing of 
redress of grievances on each side. 

Arbitration and Conciliation — This leads us to the 
consideration of some of the suggestions for settling 
disputes. Of these principally there are two varieties. 
The first is arbitration. The usual method is for each 
party to choose a representative on the board of arbi- 
tration and for these two, or some outside body like 
the Department of Labor, to nominate a third. Arbi- 
tration, however, is limited in its scope. If there has 
been an existing agreement between the disputants, 
who cannot agree upon the interpretation of this agree- 
ment, arbitration may be of some value. If, on the 
other hand, the question arises of making a new 
agreement, arbitration is unsatisfactory. 

If the two parties to the dispute are so at loggerheads 
with each other that the settlement seems impossible 
without a trial of strength through a strike or lockout, 
then it may be possible for a disinterested outsider to 
endeavor to bring the two together and eliminate the 
principal points of disagreement and bring about a 
settlement of the dispute. This method, the method of 
conciliation, is more useful in coming to a new agree- 
ment than in interpreting an old one. 

Governments have, from time to time, insisted that 
one or other of these last two methods should be 
attempted before coming to a strike or lockout. One 
very strong objection has been urged, on the part of 
the workmen, against arbitration. They argue that in 



THE ORGANIZATION OF LABOR 387 

a great proportion of the cases, the board is composed, as 
far as its majority is concerned, of people who have 
an instinctive although often unconscious bias against 
the labor side. The lawyer or judge who is often chosen 
as chairman of the board is almost always drawn from 
the same class as the employer. 

The Boycott and the Union Label — Another method 
of forcing employers to grant demands of laborers is 
the use of the boycott. This means that the unions, 
and as many others as the unions can persuade, refuse 
to purchase, use, or handle goods made by the re- 
calcitrant employer. This is answered by the black- 
list on the part of the employers. Objectionable 
workmen, i.e., those who have been prominent in union 
agitations, are refused work wherever they apply. 

To some extent the unions endeavor to enlist the 
general consuming public on their side, by urging them 
to purchase only such goods as are made under good 
conditions. The public is able to judge which are so 
produced by a label which is attached when the goods 
are made by union labor. Employers have themselves 
made use of this sympathetic feeling on the part of the 
public by advertising the fact that their manufactures 
bear the union label. 

The Success of Trade Unionism — It is very diffi- 
cult to estimate the success which has been attained 
by the trade unions. The estimate varies according 
to the standing of the estimator. There cannot be 
any doubt, however, that the trade unions have been of 
great assistance in raising the standard of life. That 
their methods have not been always those of the most 
enlightened may be granted. On the other hand it 



388 AN INTRODUCTION TO ECONOMICS 

cannot be said that a very satisfactory example has 
been given by their employers, who have usually, at 
any rate, the advantage of a better education. 

Trade unionism has served to bring forcibly to the 
eyes of the public the fact that workers have rights as 
well as duties. It is unfortunate that society has not 
been able to learn this lesson without bitter suffering 
on the part of the unionists themselves, and very great 
inconvenience, if not actual suffering, on the part of 
the community. 

In the foregoing discussion care has been taken to give 
a fair account of the aims and methods of organized 
labor. Many individual cases of unjustifiable methods 
have been overlooked. It is not suggested that in 
every case of a dispute the workmen have invariably 
been in the right. This is, of course, untrue. Nor is it 
suggested that in defending their own position, em- 
ployers have always been oppressive. It would be 
quite impossible in the space which we can give to 
this discussion, to deal adequately with all sides of the 
question. There have been grievous mistakes on both 
sides but, taking a broad view of the development of 
the principle and methods of collective bargaining, and 
of the trade unions themselves, it is demonstrably true 
that they have been of immense service not only to their 
own members, but also to the general community in 
raising standards of living and thus helping to provide 
for a higher development of humanity. 



CHAPTER XXVIII 

DISTRIBUTION AND THE LABOR PROBLEM 

From the remarks made in the previous, chapter it 
should be clear that the great problem which has con- 
fronted the laboring classes, using the term in the 
commonly accepted meaning, has been the readjust- 
ment of the distribution of wealth. The laborers have 
felt that they were not getting a fair share of the 
wealth produced. They have not been blind to the ob- 
vious distinction between the great fortunes on the one 
hand and the practical poverty of great masses of 
the people on the other. It is not true to suggest, 
however, that the workmen have always had their eyes 
focused on these inequalities. If they had, one can 
hardly doubt that revolutions would have occurred 
before this. In order to understand the history of the 
labor movement a little insight into ordinary psychology 
is valuable. Few of us are capable of taking a broad 
view of life or of weighing arguments pro and con on 
important subjects. We all, or nearly all, consider 
those things which immediately and obviously affect 
us as of most importance. Consequently when there is 
discontent, the causes which are alleged to have pro- 
duced this discontent are almost as many as the number 
of the discontented. 

Petty difficulties arising in an individual plant 
or workshop may be the apparent cause of a totally 

389 



390 AN INTRODUCTION TO ECONOMICS 

disproportionate dispute. We are all prone to gen- 
eralize from our personal experience and to reject as 
irrelevant causes of evils which are suggested by those 
who have only a " theoretical " acquaintance with the 
subject. The writer once suggested to a group of 
workingmen, mostly trade unionists, that a thorough 
acquaintance with the history of the trade union 
movement would help to remove from the discussion 
of possible remedies for discontent, causes which, 
though they might exist, were of slight importance. 
One workman replied that he did not intend to 
read the history suggested as it "might change his 
opinions." 

Now this is obviously an absurd standpoint, but it 
is not an unnatural one. Those causes of which we have 
immediate knowledge invariably have more influence 
with us than those which are the result of investigation 
extended into unfamiliar ground. Hence we find all 
sorts of wild ideas as to the causes of inequalities in the 
distribution of wealth. It is quite impossible in the 
present work to deal with all of the causes of evils in 
distribution which are believed by one or other group 
to be important. Furthermore it is impossible to do 
more than cite a few of the remedies proposed. 

Essentially we may distinguish four criticisms with 
the corresponding proposals for removing the bases 
of these criticisms. The first is to the effect that the 
workers do not receive a share in the profits of industry ; 
the second, that industry is not subject to control by 
the workmen ; next, the tax system is claimed to be 
unjust; and finally, the whole foundation of our 
economic life, as it is at present organized, is declared 



DISTRIBUTION AND THE LABOR PROBLEM 391 

to be wrong. Of these criticisms we shall leave for 
future consideration the last, and the most important, 
and deal now with the first three. 

Profit Sharing — The feeling that the workers, that 
is, the employees in a business should receive a share 
in the profits of that business or industry is one which 
has been advocated rather by those in control of the 
industry than by the workers themselves. Indeed it 
may be said that the schemes of profit sharing which 
have been proposed from time to time have been 
regarded very unfavorably by organized labor. This 
is due to the fact that, from the labor point of view, 
the reason for profit sharing is not the same as that 
which gives rise to its institution by the employer. 
There are, speaking broadly, three different systems of 
profit sharing. In the first place a definition of 'profits 
has to be arrived at. As a rule, a certain amount of the 
earnings is earmarked for the payment of interest upon 
capital and salaries of management. Commonly, cap- 
ital is expected to receive a rate of interest somewhat 
larger than the average commercial rate, before profits 
are computed. Salaries of management are considered 
(and rightly so when they are not obviously excessive) 
as part of the cost of production. The surplus after 
paying for cost of production, including cost of manage- 
ment, labor, materials, and the stated rate of interest 
on capital, is divided in varying ratios between labor, 
management, and capital. 

The first method of making the payments to labor is 
to give the share as a cash bonus at the end of the year. 
This has frequently been the first method adopted by 
a firm in starting the system. It is claimed, by the 



392 AN INTRODUCTION TO ECONOMICS 

employers, that this system produces steady and ener- 
getic laborers. From the employer's point of view, 
therefore, the aim of the institution of profit sharing 
is to increase the production of the laborers and to 
lessen the " turn-over " of labor. From the labor 
point of view, it is suggested that the profits which 
the laborer receives at the end of the year are really 
only wages for the increased production and therefore 
are due entirely to the laborers. It is assumed that 
capital is not increased and that the management is 
not materially more diflBcult, so that the increased pro- 
duction is due definitely to the increased energy of the 
workmen. But capital, which has done nothing more 
than usual, receives a share out of this increased profit 
and so also does the management. Hence the laborer 
is induced to work harder for the sake of getting at 
best a little more than a third of the results of his 
increased production. This is the basis of the labor 
criticism of this form of profit sharing. 

The next form is that in which the dividend is not 
paid in a lump sum at the end of the year, but is 
deferred to form a sort of pension fund or life insurance. 
The varieties of this form are very great and so a 
general statement is liable to err in regard to indi- 
vidual cases. It is often stipulated, however, that the 
deferred payment ceases to belong to the worker 
should he leave the employ of the company. This 
system is also believed by those who have tried it to 
lead to steady work and increased production. Against 
it, the laborer has urged that its effect is to prevent 
the possibility of successful organization of laborers. 
The unions have regarded such systems as being subtle 



DISTRIBUTION AND THE LABOR PROBLEM 393 

forms of attacks on organized labor — " union-breaking 
schemes." 

The same claims are made, on both sides, for the third 
form. In this form the dividend of profits is not made 
in cash, or is made only partly in cash, the bulk being 
paid in the form of stock in the company, so that the 
workmen become shareholders. In some cases it has 
been stipulated that such labor-owned shares shall not 
possess the voting right at the stockholders' meetings. 
In others the stock has not passed outright into the 
hands of the supposed owner, but is merely his while 
he remains an employee of the company. 

It would seem that in all the schemes of profit sharing 
there is a distinct idea that increased profits would be 
made by the introduction of the system. It is sup- 
posed to lead to increased effort on the part of the 
workmen, while in a great many, though by no means 
all, cases, the workman is compelled to remain in the 
employ of the company on pain of losing his accumu- 
lated profits. 

On the whole it may be said that profit sharing cannot 
be judged entirely by the method which is adopted. In 
some cases a real effort is made to give the workman a 
share in the returns received by the company, a share 
additional to the standard rate of wages which he 
receives as a minimum. In these cases an attempt 
has been made to make the connection between work- 
man and employer a little more human, to regard the 
workman as a partner in the business rather than as 
a piece of fixed capital, easily replaced. In other 
cases the criticism that the profit-sharing methods are 
merely union-breaking schemes is fully justified. In 



394 AN INTRODUCTION TO ECONOMICS 

one English scheme, for instance, the cash which a 
workman received at the end of the year, as dividend 
upon the share of stock which was his portion of the 
divided profits, amounted to about a couple of dollars. 
The share belonged to him as long as he stayed with 
the company and it was given to his heirs if he died. 
Should he leave the employ, however, he forfeited his 
share. Practically, therefore, if he wished to retain 
his freedom to go to a different job, the actual amount 
received in return for his increased effort was about 
two dollars a year. 

At best profit sharing does not answer the criticism 
that the wealth produced is not equitably distributed. 
It is a palliative of the existing distributive evils. It 
depends entirely upon the will of the individual em- 
ployer or company both for its institution and for its 
method. 

In the actual application of the various forms of 
profit sharing the success, both from the laborer's 
point of view and from the employer's, has varied 
very greatly. The majority of the attempts have 
been given up. Of the remainder some exist in theory 
only. Where a certain rate per cent is demanded as a 
preliminary share for capital, and the earnings barely 
suffice to pay this rate, obviously there can be nothing 
to share with the workers. The scheme may be good, 
but it is simply inoperative. 

Judging from past experience it may be said, in sum- 
ming up our discussion, that individual types in individ- 
ual cases have been successful, but as a system profit 
sharing has failed from whatever standpoint it be 
regarded. 



\ 



DISTRIBUTION AND THE LABOR PROBLEM 395 

Co-operation — The second criticism of existing 
economic organization is that the workman has no 
share in the control of his work. To remedy this it 
has been suggested that he gain the control by the 
establishment of industries co-operatively owned and 
managed, and we have the co-operative systems offered 
as the antidote to the evil. 

Co-operation, however, may be regarded from two 
standpoints. Omitting all consideration of the fact 
that in order to have anything like success in any 
organization there must be co-operation between the 
various members of the organization, the co-operative 
systems may be considered from the point of view 
of co-operating consumers and co-operative producers. 
The form in which the co-operative ideas as translated 
into practice have had the greatest success is that of 
consumers' co-operation. The idea first arose with the 
establishment of a little co-operative society in Roch- 
dale, a Lancashire cotton town. The aim of the 
Rochdale Pioneers was to purchase all their require- 
ments from a store owned and operated by themselves. 
Each of the members subscribed toward the small 
capital of the society, but each had one vote and one 
vote only in the management, altogether apart from 
the amount of capital invested. This principle has 
been maintained almost invariably with co-operative 
societies. The idea is that the store should be managed 
in the interests of all without distinction in regard to 
individual possessions. The organization was intended 
to be as democratic as possible. 

Since the establishment of the Rochdale Pioneers in 
1844 there have been very many imitators of the 



396 AN INTRODUCTION TO ECONOMICS 

system. In the main the methods of operation are 
similar, no matter in what country they have been 
conducted. The " members " of the society subscribe 
for at least one share of capital, upon which they receive 
a dividend limited to a certain sum. The society 
organizes a store and sells goods sometimes only to 
members, sometimes to the general public as well. The 
prices charged are the same, or nearly so, as those 
charged in the ordinary privately owned stores. The 
profits of the society, however, over and above the 
small interest on the capital, are divided among the 
purchasers according to the amount of their purchases. 
In some cases these " dividends " are restricted to the 
members of the society, that is, to those who hold one 
or more shares. In others, each purchaser, whether 
member or not, is entitled to receive his " dividend " 
at the end of the accounting period. 

Experience has taught co-operators in all countries 
that these small co-operative stores are largely at the 
mercy of the wholesale dealers. The latter depend 
for the great bulk of their trade upon the orders received 
from the ordinary privately owned stores. A little 
organization among these stores will enable them to 
bring pressure to bear on the wholesalers to give them 
discriminating treatment. Prices to the co-operative 
stores are raised, and hence profits are reduced or 
actually disappear. 

The remedy for this discriminating treatment is to 
establish co-operative wholesale stores. In this case 
the groups of co-operators in different stores combine to 
establish a wholesale store which will deal with them 
alone and directly with the manufacturers of the goods 



DISTRIBUTION AND THE LABOR PROBLEM 397 

sold. As far as the co-operators in England are con- 
cerned, and the system has made great headway there, 
the wholesale difficulty has been very well met by the 
establishment of the Co-operative Wholesale Society, 
which does an enormous business with co-operative 
stores throughout the country. In America there has 
not been anything like the conspicuous success in such 
co-operation as there has in the European countries, 
for reasons which will be mentioned later. 

One of the great difficulties which these co-operative 
stores have had to solve is that of efficient management. 
It does not pay to assume that any one can keep a store. 
Yet at the beginning of the co-operative movement that 
was the general assumption. In the Rochdale society 
each of the twenty-eight members took turns in " mind- 
ing the shop " and in keeping the simple accounts of the 
store. As the movement developed, case after case of 
failure was seen to be due to this amateur management, 
and in Europe, at any rate, co-operators have realized 
that management of a retail store calls for qualities 
and knowledge which are not common property. 
Hence the modern, well-organized co-operative store 
is managed by expert retailers. As, however, paid 
salesmen and managers have to be obtained, the diffi- 
culty arose as to the status of these men in the co- 
operative scheme. In some cases, the co-operators 
have not recognized their employees as being in any 
way partners in the organization, but have hired them 
in exactly the same way as a commercial corporation. 
In others the employees have been shareholders and 
therefore had a right to a vote in the management. 

Co-operative consumption has not met with much 



398 AN INTRODUCTION TO ECONOMICS 

success in the United States. The reasons for this are 
various. In the first phice co-operation, to be successful, 
demands a certain amount of loyalty to the society — 
a sinking of the individual in the common organization. 
This is not easy to obtain in America. The American 
is almost aggressively individualistic. He is accus- 
tomed to rely upon himself, and if for a while he 
sees that it would pay him to co-operate, it is only 
for a while, and very little is necessary to make him 
give up the organization. Again there has been very 
little community of action between the co-operative 
societies when started. There has been no state 
organization, much less national organization, so that 
co-operative societies in one part of the country could 
know of and appreciate the work done by others. 
With this lack of co-ordination in the system the in- 
dividual societies have been almost entirely at the 
mercy of the wholesale dealers, whose largest revenue 
came from the privately owned establishments. Hence 
discrimination against co-operators became easy, and 
was difficult to combat. 

Co-operative Production — As we have said, co-opera- 
tive consumption is only one side of the matter. If 
co-operation is to be really successful and to become 
an important element in our economic organization, it 
must not be confined to consumption. Production, 
also, must be attempted. It is in the realm of co- 
operative production that the most dismal failures have 
been seen. Occasionally we see a success in this line, 
but, as a rule, the result is more or less qualified failure. 

Capital has almost always been too small to permit 
of the introduction of the best methods. We have 



I 



DISTRIBUTION AND THE LABOR PROBLEM 399 

seen in an earlier chapter that in the establishment of 
productive businesses (using the word productive in 
its ordinary colloquial meaning) the tendency is 
strongly toward the increase of the amount of fixed 
capital required. Usually this means a certain period 
of waiting before results may be obtained which may 
be regarded as profits. The average co-operator, 
especially in America, is strongly inclined to be im- 
patient. Hence there is no chance of the industry 
being successful. Returns cannot be gained imme- 
diately. If the machinery is not of the best and latest 
models, the products are obtained at a disadvantage 
which means that even when profits are made, they 
are smaller than those of industries working under more 
favorable conditions. The co-operative producing or- 
ganization tends to exist near the margin of operation. 
A little fall in the returns, and the profit line is over- 
stepped. 

Competition from the better organized factories, then, 
can easily force the co-operator below the profit line 
and then the end is not far off. 

No space can be spared to give instances of co- 
operative management, but a word or two as to the 
relation between co-operation and the competitive 
system will be of value. Co-operation, as it has been 
practiced, accepts the competitive system. It fixes 
its prices on the same basis that they are fixed in 
ordinary commercial life, i.e., where there is a possi- 
bility of gaining a monopoly price, that price is charged, 
but where the price is fixed by the more or less free 
interplay of the laws of supply and demand, the co- 
operators accept that price. Experience has taught 



400 AN INTRODUCTION TO ECONOMICS 

them that under present conditions this has been the 
best method to pursue. At times the experiment of 
selHng at cost (cost to include expense of management) 
has been tried. Ahnost invariably, however, it has 
been seen that where it was possible to charge thus, 
the purchasers were not so pleased as when they paid 
the ordinarj'^ price and received a dividend. In most 
cases, however, it was impossible to charge thus. For 
instance, under careful calculation the cost of a pound 
of butter might amount to thirty-seven and one half 
cents. The selling price, therefore, had to be at least 
(on individual pounds) thirty-eight cents, or there 
was a loss. Exaggerate this by applying it to all 
the commodities stocked, and consider the difficulty 
of estimating the exact share of overhead expense 
and expense of selling of one commodity and another, 
and the very great difficulty of instituting a cost price 
becomes obvious. 

Experience has also taught co-operative consumers' 
associations that the purchasers were very interested 
in dividends (" divvy-hunters " is a common expres- 
sion among English co-operators) and did not object 
even to an increase over the ordinary commercial 
price, provided good dividends were paid. If attention 
is paid to the dividend alone, the system merely becomes 
one of compulsory saving, and ceases to have any of 
the real benefits assumed to arise out of co-operation. 

As there seems to be no possibility of the co-operative 
system obtaining a strong hold on America, or indeed, 
on the European countries, it is not worth while to 
examine the result to be expected should the system be 
extended to cover all industry and to eliminate all 



DISTRIBUTION AND THE LABOR PROBLEM 401 

competition. Co-operation is not a scheme for a re- 
organization of the commercial system. It is a palHa- 
tive of some of the evils of competition. As such it has 
its uses, but it is in no way to be regarded as a solution 
of the difficulty. 

Equality of Taxation — The third criticism which is 
leveled at the existing distribution of wealth is to the 
effect that the contributions paid toward the expenses 
of government are not properly shared. The science of 
taxation is very complicated, and we are compelled by 
reasons of space to restrict our consideration of this 
subject to the smallest compass. 

We assume that government must exist. There is no 
possibility of a great mass of people existing together 
unless they agree upon rules of conduct, and provide 
means for enforcing those rules. There are some forms 
of economic activity which are essential to the well- 
being of all, but which are not usually carried on by 
private individuals. Questions of police, of sanitation, 
of justice, of the safekeeping of the roads and of the 
seas are all of great importance, but no one would 
expect a private individual, acting under the com- 
petitive system, to erect a lighthouse at his own expense, 
without the privilege of collecting a toll from passing 
ships. Nor would we expect him to pay a judge to 
administer justice, unless, indeed, he expected that 
judge to see the law from the point of view of the 
interest of his employer. Without, at present, going 
into the functions of government, it is sufficient to 
assume its necessity. The question then arises of the 
payment of the expenses of government. Under what 
basis should they be distributed .f* 



402 AN INTRODUCTION TO ECONOMICS 

Should landowners only be taxed, and if so, how 
much? Should corporations pay a share, and if so, 
should it be based upon their capitalization or upon 
their profits ? Should the incomes of all be used as a 
basis of taxation? These and many other questions 
must be solved. We cannot go into all of these 
questions, but some of the principles which underlie 
their solution can be discussed. 

In the first place we must distinguish two points of 
view. The secretary of the treasury or chancellor of 
the exchequer, or whatever name may be given to the 
individual responsible for the proposal of taxation, 
has one distinct point of view. He must decide how he 
can get the largest amount of tax revenue and how he 
can obtain this with the least opposition. The tax- 
payer, on the other hand, is interested in having his 
own individual share reduced as low as possible, or at 
least, if he is a little more altruistic than the ordinary 
person, he wants the taxes to be distributed so that 
the burden falls upon the back best able to bear it. 

It is generally assumed, nowadays, that the burden 
should be placed where it can most easily be borne, 
rather than equally. Equality of sacrifice is sought, 
rather than equality of amount in taxation. This is 
extremely important in deciding on the imposition of 
direct taxes, such as, for instance, the income tax. 
Suppose a straight tax of five per cent were made upon 
all incomes. From the arithmetical point of view that 
would be a fair method. But it is not so from the more 
human point of view, which takes into account the 
sacrifice involved. Five per cent of a wage amounting 
to $1000 per annum means a payment of $50. Five 



DISTRIBUTION AND THE LABOR PROBLEM 403 

per cent of a salary of $50,000 per annum is $2500. 
The sacrifice of $2500 by the man with the large income 
is hardly felt. One cannot think that he will give up 
anything of importance through the diminution of his 
income. On the other hand the man who pays 50 dollars 
out of an income of 1000 dollars feels very keenly the 
loss of the money. His sacrifice is very much greater 
than that of the wealthier man. 

The same thing is true of taxes levied not directly, 
but on commodities. The man whose income is only 
sufficient to supply him with the bare requisites of life 
is bound to feel very severely anything which tends 
to increase the cost of those requisites, while the 
wealthier man feels them very slightly if at all. 

It is sometimes argued, too, that taxes are the pay- 
ment made for a definite service rendered by govern- 
ment — services like the securing of liberty, the pre- 
vention of theft, the provision of sanitary cities, the 
care of the sick in public hospitals, the protection of the 
country against enemies. As all are supposed to be 
equally benefited by these services, the payment from 
each should be equal. Against this, however, it is 
urged that the services are not the same to each. To 
the poor, whose property is nothing, the protection 
against theft is of slight importance, while it is of 
great importance to the man of property. Hence 
as the service is greater to the latter, he should pay 
more. 

Again, some of the services are distinctly personal. 
For example, the machinery which safeguards patent 
rights for inventors affects only the inventors. They 
should be required to pay for those services much as the 



404 AN INTRODUCTIOX TO ECONOMICS 

person who rides in a municipal street car is made to 
pay for the service rendered. 

In actual practice a compromise is effected by the 
tax makers. In some cases a specific charge is made 
for the services rendered by the state. This class of 
tax is usually referred to as a fee, and comes under 
the same category as a fee charged by a doctor or 
lawyer. In others, the tax is laid directly upon the 
commodity, like the tax on tobacco, for example. In 
this case each pays in proportion to the amount of the 
commodity he uses. 

As a matter of reform in the distribution of wealth, 
it is doubtful whether improvement in tax methods 
can be of any great service. It is, of course, true that a 
great deal of injustice can be effected by changes in 
the method of obtaining government revenue, but their 
proportional effect upon distribution can be very much 
overestimated. In exceptional times, of course, there 
is opportunity for the government to obtain a greater 
share from certain individuals than in normal times. 
In the case of war time, for example, we have an 
unusual situation where men in certain businesses have 
reaped very great profits through the sudden increase 
in demand for the commodities they manufacture. 
Steel manufacturers, munitions makers, clothing con- 
tractors, and each of the thousand and one different 
trades which are affected by war requirements, have 
been able to make enormous profits. As these profits 
are directly a charge on the general community, a 
charge due to the fact that the manufacturers concerned 
have taken direct advantage of the government's 
needs to increase their prices, the government is 



DISTRIBUTION AND THE LABOR PROBLEM 405 

certainly entitled to take, if not all the additional profit 
above normal rates, at any rate the greater proportion. 
Hence we see the institution of the excess profits tax, 
which levies toll upon these abnormal profits. Heavy 
as has been the taxation on this basis, it cannot be said 
to have been too heavy and no one has worried much 
about the opposition of certain interests to the im- 
position or increase of such taxation. 

Under the present system of economic organization, 
where distribution is obviously unequal and inequitable, 
there can be no doubt that the basis of equality of 
sacrifice is the best upon which to work in securing 
the funds necessary for the support of government. 
Equality of sacrifice in taxation necessitates what may 
be called progressive taxation. Taxation is pro- 
portional when the rate levied varies arithmetically 
with the amount to be taxed. That is, when the same 
percentage is charged no matter how high the amount 
be, the taxation is proportional. But we have already 
seen that merely proportional taxation is not satis- 
factory in securing equality of sacrifice. Hence in 
direct taxation, particularly in regard to income taxes, 
the best method is to increase the percentage paid as 
the amount of income increases. It is impossible to 
estimate mathematically how the taxation should be 
graded, for each man's income has special considerations 
which require to be regarded. Some men gain great 
incomes by their own exertions — successful lawyers, 
doctors, actors, manufacturers, for instance. Others 
sit still and do nothing but draw dividends. In the 
latter case, seeing that no duties are performed by the 
individuals in question, it is right that they be called 



406 AN INTRODUCTION TO ECONOMICS 

upon to pay pretty heavily for their support in idleness. 
In regard to the others, they are at least supplying some 
demand directly, and in so far they are deserving of 
encouragement by the community. This leads us to 
the distinction between earned and unearned incomes, 
the latter being taxed at a heavier rate. 

As has been said, however, the distribution of wealth 
will hardly be materially affected by reforms of taxation 
while the taxation is levied with the pure aim of 
securing sufficient and only sufficient revenue to run 
the government of the country. A much more im- 
portant suggestion is a revolution of the ideas as to the 
economic functions of government. As a great many 
of the schemes of economic reorganization are based 
upon such a fundamental revision of our ideas on 
these functions, it will be well to leave their con- 
sideration to the next chapter. 



CHAPTER XXIX 

THE ECONOMIC FUNCTIONS OF GOVERNMENT 

Most of the theories upon which are based the pro- 
grams for redistribution of wealth have their origin 
in the beHef that the economic system under which we 
Hve at present is wrongly founded. The suggestions 
which have been discussed in the previous chapter are 
considered as mere tinkering with the organization, 
when what is required is a thorough rebuilding upon a 
new foundation. ■ 

In nearly every case the suggestions for the new 
foundation of economic society include a very con- 
siderable increase in the economic functions of govern- 
ment. It will be well, therefore, before we can deal 
properly with the schemes of social and economic re- 
construction which are of such enormous importance 
at the present time, to analyze carefully the economic 
functions of government as they now exist. We may 
divide them into three classes, the protective func- 
tions, the regulative functions, and the operative 
functions. 

Protective Functions — Even the strongest believer 
in the theory of laissez faire will be quite willing to 
admit that government has certain duties to perform 
which are of an economic nature. Free competition, 
which is essential to the laissez faire system, cannot 

407 



408 AN INTRODUCTION TO ECONOMICS 

exist unless the law of contract is made effective. 
All our trade depends to a large extent upon the fact 
that individuals on the whole are ready to fulfill their 
obligations when and as they arise, but some compul- 
sion must be exerted upon those who refuse to live up 
to these obligations. The law must step in to protect 
the individual against those who receive the benefit 
of one part of the contract and refuse to perform the 
per contra. 

Again it is recognized that some parties to contracts 
are not in a position to protect themselves against 
exploitation by others. This is particularly the case 
in labor contracts. Children are certainly not able to 
secure just treatment themselves. If their parents 
force them to work before they are really strong enough 
to earn their own living, there is nothing, except 
government action, which can prevent their exploitation 
successfully. Child labor laws are essential to any well- 
ordered state. But child labor laws only represent 
the beginning of the government's protective work in 
regard to labor. Women's labor must also be pro- 
tected, and indeed men's labor as well. There was a 
time when it was common to work for sixteen or more 
hours per day. This is not the case now. Govern- 
ment has stepped in, time after time, to restrict the 
hours of labor. Government has also interfered, and 
wisely so, in the manner in which workshops and 
factories are conducted. Sanitary laws have been 
passed, as also have laws against the use of unfenced 
machinery, unsafe scaffoldings, and so forth. 

The general security of the country against foreign 
invasion is part of the function of government. This 



THE ECONOMIC FUNCTIONS OP GOVERNMENT 409 

is comparable, although it is on a larger scale, with 
the police protection afforded the individual in our 
cities. 

Our ocean trade and coast trade are protected by 
proper mapping of the harbors and sea passages. 
Lighthouses are maintained at government expense. 
It is obviously impossible to expect that private in- 
terest will erect and maintain lighthouses, yet they are 
necessary to safe trading. 

Regulative Functions — The history of government 
economic activity since the industrial revolution is full 
of examples of increase in the regulative functions of 
government. It was pointed out in an earlier chapter 
that a distinct change has taken place in the nature of 
government regulation, however, and it is worth while 
now to consider the change in some detail. The theories 
of economic organization to which the name of laissez 
faire has been attached, were very largely due to a 
reaction against the old-fashioned method of govern- 
ment regulation of trade and industry. Such regulation, 
consisting as it did in laying down rules for the conduct 
of industry, rules which were to guide the manu- 
facturers in the methods to be used in industry and the 
products to be manufactured, was felt to be interference 
rather than regulation. With the advent of the new 
machine production the irritating interferences of 
government were bitterly resented. 

As is quite often the case, it was not seen at the time 
that a change in the nature of government regulation of 
industry was required. The manufacturers demanded 
the entire and complete abolition of all regulation. 
Industry was best when it was left most alone ; govern- 



410 AN INTRODUCTION TO ECONOMICS 

ment which did the least governing was the best form 
— these were the cries. 

Experience soon taught, however, that government 
could not let industry alone. That selfishness which 
was supposed to be the foundation of successful 
economic organization showed, in practice, that it had 
lost little of its ancient evil. While it did secure a 
wonderful addition to the total wealth of the country, 
it succeeded also in changing the relative distribution 
to an enormous extent. The strong prospered and the 
weak were driven to the wall. Modern feelings of 
humanity prevent us from considering that the weak 
are better killed off. We realize, and should realize 
even more strongly than we do, that if the weak were 
driven off and society consisted only of the strong, the 
loss would be to society. This is especially so when 
we consider economic strength. The ability to make 
money is not the only ability of which society stands 
in need. This is obvious if one considers for a moment 
what life would be like if every one of us devoted his or 
her attention solely to the purpose of gaining as much 
wealth as possible. Our music would degenerate into 
rag-time, our artists into poster painters, and our 
actors into " movie artists." We are not decrying 
any of these forms of self-expression, of course, but it 
must be admitted that much of the best of life would 
be lost if money were the only consideration. 

In order to prevent a crude conception of economic 
organization from ruining the world, government had to 
step in to regulate the working of the system. It has 
been shown in the previous pages that the tendency of 
economic development is towards the elimination of 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 411 

competition. But while that tendency exists to a very 
strong degree there exists at the same time a strong 
tendency for the control of the larger units which have 
superseded the small competitive units, to pass into 
the hands of a comparative few whose main idea is not 
the service of the public, but the gaining of profit. 

Large-scale production undoubtedly secures economy 
of effort in production, but that economy is of no real 
benefit to society unless society as a whole shares 
in the profits. The dangers of powerful monopolies, 
controlled by individuals whose concern is merely 
profit making, are obvious and there is no need to labor 
the point. Government must step in to see that the 
monopolies or quasi-monopolies are so conducted that 
benefit and not loss results to society. 

It is for this reason that we have our railroad com- 
missions and interstate commerce commissions — our 
anti-trust laws and bank acts. A point is reached, 
however, when there is little real distinction between 
control and ownership, except in operation. If the 
trusts are so controlled that they cannot manipulate 
prices to suit themselves, much of their value to those 
who have organized them is lost. The public, however, 
is benefited by the economies of production, provided, 
of course, that the trusts have been organized on a 
sound productive basis. But if the government does 
so control the trusts, and profits to the owners sink to 
the level of commercial interest, the trust owners 
become practically shareholders in a government 
organization. 

Again, in the case of railroad regulation and control, 
the control may be exercised so stringently that the 



412 AN INTRODUCTION TO ECONOMICS 

railroad owners are also in the position of government 
bondholders. 

The difficulty has been to decide where to stop. 
It is not our intention to give details of control as 
exercised by our government. It must be pointed out, 
however, that there are certain industries which are of 
the nature of monopolies. They cannot be successfully 
operated unless they are worked on a very large scale. 
These are the so-called " public utilities." Every one 
recognizes that competing telephone systems are un- 
desirable. The telephone system in a city should be a 
unit, not two or three units. The same is true of street 
car service. To a less extent, perhaps, the same is also 
true of railroads. Two railroads, separately conducted 
and organized and following the same routes, are uneco- 
nomical. For this reason, these public utilities, whether 
owned by the public, i.e., the government, or privately 
owned, must be permitted to work as monopolies. 

They must be closely controlled, however, in order 
to protect the right of the public as against the rights 
of the individuals who own the stock in the monopoly. 
At present, the extent of the regulation depends greatly 
upon questions of practical statesmanship. This mat- 
ter will be further considered later. 

Operative Functions — The student will have realized 
that the regulative functions of government, carried 
to extremes, tend to overlap into the operative. There 
are, however, some operative functions which the 
governments all over the world, practically, retain in 
their own hands. The outstanding instance is, of 
course, the carriage of mails. The post office is an 
institution which few, even of the most rabid. 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 413 

individualists would like to see again in private hands. 
We seldom realize to what a tremendous extent civi- 
lization depends upon the free and cheap carriage of 
mails. A little consideration, however, will serve to 
show the extreme importance of this function. If any 
industry must be carried on as a monopoly in order 
to serve its purpose well, it is this. 

The supply of transportation, however, is almost as 
important. Hence it is in this instance that we find the 
next most common of the operative functions. It is 
true that the national government is not so usually 
concerned as the municipal. But the fact that trans- 
portation within the confines of a city tends more and 
more to become the care of the civic authorities does 
not take away from the governmental nature of the 
operation. There are few cases, moreover, where the 
cities which have once undertaken the management of 
their own transportation systems have relinquished that 
management into the hands of private corporations. 

The same is true of the supply of water and of light 
and heat. The question then arises, how far is the 
governmental function of operating industries either 
in competition with or in supersession to private 
operation, to be extended. There are some cities that 
run their own electric car systems, but do not supply 
their own water. Others supply their own water but 
not transportation. Some own their telephone systems, 
but not their gas and electricity. In some countries 
the government owns the railways entirely ; others 
have both government and privately owned railway 
systems ; while in still others the railway systems are 
privately owned and operated. 



414 AN INTRODUCTION TO ECONOMICS 

Government or Private Ownership of Public Utili- 
ties — The question as to whether public utihties should 
be owned by the pubhe themselves or by private in- 
terests is one which cannot be given a general answer ; 
so much depends upon the individual instance. It is 
important to remember, however, that government 
itself consists only in the relegation to certain in- 
dividuals of a certain amount of control over others. 
These individuals frequently abuse the power placed 
in their hands. Frequently they make grave mistakes. 
To take hypothetical instances, we may say quite 
definitely that where the government consists of in- 
dividuals who are not trusted by the governed, or 
where they are notoriously inefficient, there is no 
question but that public utilities should remain in 
the hands of private enterprisers. Where, on the 
other hand, the government has proved itself both 
honest and capable, a strong case is made out for the 
operation of public utilities by the governmental or- 
ganization. 

It is well to remember, too, that because government 
has failed in a particular case to give a good account of 
its operations that is no argument against the general 
case for government ownership and operation of public 
utilities. In a recent work it was argued that because 
a certain government had failed miserably in working 
a telephone system, dishonesty and inefficiency being 
evident in all its workings, therefore the case for govern- 
ment ownership of telephones was entirely lost. As a 
matter of fact, however, that same government had 
shown itself utterly incapable of administering jus- 
tice with the least degree of equity. If the former 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 415 

argument held good, then it was just as conclusively 
proved that law and order should be in private hands. 

Private enterprise has advantages that it would be 
absurd to underestimate. With profit as the great aim 
of life, a vast multitude of different satisfactions have 
been produced. The fullest development of the in- 
dividual activity, self-seeking, has made possible the 
sustenance of a great population. Countries which 
formerly supported with difficulty a population of a 
few millions now support with comparative ease many 
times that number. During the past hundred years 
inventions of labor-saving machinery have been million- 
fold; so also have inventions to satisfy our sesthetic 
senses. Men have expended every last ounce of energy 
they have possessed in the service of their fellows. It is 
not true, however, that they have always realized 
this service and have taken it for their aim. The 
service has been incidental ; but it nevertheless existed, 
and that much must be granted to the individualistic 
system of private enterprise. 

Lessons of the War — A system is not properly tested 
in normal times, however. It must stand the strain 
of a crisis before we can say that it is really successful. 
At the present time, we are in the midst of one of the 
greatest crises in the history of the world. The great 
war is practically ended, and we cannot afford to be 
blind to the lessons which it has taught us. It is not 
within the scope of our study to inquire into the moral 
aspects of war or into the political causes and results. 
War, however, is very largely an economic problem, 
especially when it is on a large scale. The colossal 
scale upon which the great war has been waged has 



416 AN INTRODUCTION TO ECONOMICS 

put an enormous strain upon our economic organization. 
In the first place it has meant the withdrawal from 
productive labor of a very large section of the popu- 
lation of the belligerent countries. Probably over 
thirty-five million men have been engaged in actual 
fighting. Add to these the great number who have 
been more or less intimately connected with purely war 
production and we enormously increase the total 
number of those whose labors are non-productive for 
ordinary purposes. 

Meanwhile, of course, the remainder of the population 
must produce all the necessaries of life, not only for 
themselves but for those who are withdrawn from ordi- 
nary production. Normally we may assume that, on 
the average, each produces enough for his support 
and for the support of his dependents. Now a much 
smaller number must labor to supply all the needs. 
But production cannot be maintained at a constant 
level during war time. If the war is to be successfully 
waged, production must be increased because of the 
enormous waste of material, a waste which is infinitely 
greater than that of ordinary life. 

Such a situation places a tremendous strain upon the 
economic organism. If it has been inefficient before, 
but the inefficiency has not been very evident, it will 
appear at once with the new strain. At the outbreak 
of the war it was quite obvious that without great 
changes the economic structure must break down. The 
first indications lay in the financial world. We have 
already noted that finance is peculiarly sensitive to 
economic disturbances. The methods of financing 
international trade are complicated and require a 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 417 

very considerable amount of trust in the fulfillment of 
promises. Now in war time some of these inter- 
national contracts simply cannot be fulfilled. Ships are 
required for the transport of men. When the enemy 
resorts to indiscriminate destruction of merchant 
ships the loss of transport facilities is very much greater. 
Without government assistance the whole structure of 
our international payment system would have broken 
down. Acceptances could not be met at maturity. 
Exchanges were subject to rapid fluctuations much 
wider than in ordinary times. Organized co-operation 
was essential unless an epidemic of bankruptcies was 
to ensue. Hence almost at the very outbreak of the 
war, we find government after government taking 
steps to prevent these bankruptcies. It is impossible 
within the limits of the present book to enter into 
details as to the methods adopted in one country 
or another. The principle which we wish to emphasize, 
however, is clear. Private enterprise, relying very 
largely upon the competitive system, succeeds fairly 
well in normal times, but in a crisis, all must realize 
the intimate interdependence of society, and organized 
co-operation must be substituted for the working of a 
laissez faire system. 

It is not in the financial realm, however, that the 
most important effects of war upon economic structure 
are seen. It is in the realm of production. The whole 
basis of production is changed. Under a system of 
private enterprise, the motive for production is not the 
rendering of services. The services must be rendered, 
of course, but this is incidental. The real motive is 
the gaining of profit to the person who performs the 



418 AN INTRODUCTION TO ECONOMICS 

service. Now the highest profit, as we have seen, does 
not necessarily mean efficient production so as to secure 
the greatest amount with the least effort. With a 
diminished working population and an enormously 
increased demand, profit, from the social point of 
view, ceases to count. What is required is a vast 
increase in production utilizing every known means of 
economizing effort. The nation could not afford to 
let private individuals take the opportunity of profiting 
by the peculiar circumstances which caused the great 
increase in demand for goods and services. 

Let us take one of the principal illustrations of the 
failure of uncontrolled private enterprise. Our rail- 
road system, or rather our railroad systems, have on 
the whole shown a wonderful power of organization, but 
they have nevertheless allowed a very great amount of 
waste effort. Competitive lines running between the 
same terminals have meant imeconomic terminal 
facilities, unequal distribution of freights, and whera 
the two lines were more than sufficient for the traffic 
to be borne, half empty trains and idle freight cars 
have resulted. Cars have often passed one another, 
going in opposite directions, with similar goods. All 
this is pure waste and is incidental to a system of 
private enterprise. This waste, however, could not 
be suffered under the crisis. Hence some co-ordmating 
effort had to be made to eliminate it. Practically, the 
only way was that which was actually adopted. The 
government took entire control of the railways. Every 
available car was used, and all cross-shipments pre- 
vented as far as possible. If the government, however, 
had merely assumed control of the railways, without 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 419 

at the same time controlling production, much of the 
possible economy would have been missed. Possibly 
the best way in which the whole operation of govern- 
ment control and organization can be seen is to take as 
an illustration the building of a merchant fleet under 
government contract. 

Illustration of Government Economic Activity during 
the War — -At the outbreak of the war the American 
merchant marine was almost a negligible quantity. 
The British owned far more ships than any other 
country, and while a good deal of British shipping was 
used to transport foodstuffs and munitions of war from 
the United States, this shipping was in great demand 
for purely British purposes. More ships were abso- 
lutely necessary to carry on the normal trade, let 
alone the abnormal demands of the war period. The 
facilities for building ships in this country, while 
sufficient for previous needs, were entirely inadequate 
for the construction of enough vessels to satisfy the 
new demands. 

The United States government, therefore, decided 
to build its own ships. It financed the existing ship- 
building companies so that they could extend their 
yards. It provided much of the funds necessary to 
build new yards. Contract after contract was let for 
the construction of ships, the total amount involved 
being several hundred million dollars. Not only did 
the government let the contracts ; it undertook to 
provide the steel necessary and the wood also, where 
the ships were built of wood. All orders for material 
of any nature required in the construction of the 
ships — boilers, machinery, anchors, chains, cable, 



420 AN INTRODUCTION TO ECONOMICS 

steel — were centralized. And it was here that the 
control of the railways played such an important part. 
The steel and other materials were sent from the nearest 
manufacturing point to the place where they were 
needed. The orders were so placed that as far as 
possible each ship-builder had sufficient material for 
his immediate needs, without laying in a great stock. 
Thus no ships were provided with machinery long before 
the machinery could be installed in the vessel, while 
others lacked machinery and were delayed in construc- 
tion. As far as was possible in such a rapidly con- 
structed organization, every available means was 
adopted to secure the whole of the ship construction 
program working as one unit. 

This system would have been quite impossible with- 
out the government organization. It would have been 
extremely difficult for the individual concerns to have 
organized themselves on such a basis that each of them 
received all that it required and as it was required. 
Under private enterprise each would have sought to fill 
his requirement for as long a future period as possible, 
regardless of the fact that others might have to delay 
construction of ships until necessary material could be 
obtained. 

The contractors were left very largely to themselves 
in the matter of construction, although government 
inspection of every part of the ships was secured. 
That there was a considerable amount of waste and 
some duplication of effort is undoubtedly true. This, 
however, was inevitable under the circumstances. 
The object was to produce ships as quickly as possible 
and regardless of the cost. No one can deny that this 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 421 

object was fully achieved. It was only possible to 
achieve it, however, under government organization. 

Now let us summarize the difference between the old 
private system and the new government organization. 
Under the old system we had fairly efficient single 
organizations competing with one another, but no 
co-ordination of general effort. Under the new, while 
there was no doubt a considerable amount of inefficient 
work, there was distinct co-ordination of general effort. 
Waste there was, too, but the waste was due rather to 
the extreme haste with which all construction had to 
be carried on. But waste existed also under the 
older system. In fact it would be safe to say that there 
was greater waste in the competitive method than 
in the new co-operative method. To counterbalance 
the waste there was a great economy of productive 
effort. This was bound to be the case when the aim of 
production was changed from the mere securing of 
profit to the increasing of the amount produced. In 
short, left to itself the private enterprise could not 
have produced the American Merchant Marine which 
has been developed in the brief space of one and a 
half years by the United States Shipping Board. 

It is not only in the line of production, however, that 
government had to take on new duties. Scarcity of 
foodstuffs and materials generally made it necessary 
to ration these to consumers. We all know how the 
government restricted the individual use of sugar, 
wheat, and other foods. We know also that the 
makers of clothing materials were restricted in the 
amount of wool that they could use. It is not so well 
known, however, that in other countries (in England, 



422 AN INTRODUCTION TO ECONOMICS 

for example) practically every manufacture was super- 
vised to the extent that the raw material was rationed 
out among the manufacturers. Instead of competing 
with one another for the use of the raw materials, each 
received a share according to his capacity to use it. 
American wheat was practically rationed out to the 
European countries who were too occupied with actual 
fighting to produce their necessary food. It is, indeed, 
probable that for a long time such regulation of food 
importations will have to be maintained. 

At the present moment we are not concerned with 
the question whether this government rationing is 
the right method or not. All that we are trying to 
show is that in a time of national crisis, the system of 
private enterprise must give place to government 
control and in many cases government operation also. 

One lesson we have learned from the experiments 
conducted during the war — a lesson which will have 
extremely important influences upon the economic 
organization of the future. In spite of the efficiency 
which has characterized industry all over the world, 
and American industry in particular, production has 
been only a fraction of what is possible. A hastily 
organized and in many respects incomplete government- 
operated system has more than doubled the total 
production in this country. With intelligent co- 
operation between the great producers, a vast increase 
in total production can be achieved, even with our 
existing knowledge of productive methods. 

There is great hope for a better economic system 
in this new knowledge. All that is wanted to make 
good use of it is the will and the exercise of the best 



THE ECONOMIC FUNCTIONS OF GOVERNMENT 423 

brains of the country on the problem of satisfying 
desires instead of reaping fortunes. 

Our war experience sheds a great hght on some of the 
theories which have been advanced from time to time 
by reformers and even by dreamers, and we shall turn, 
in our final chapter, to a consideration of some of 
the most important theories of social and economic 
reconstruction. 



CHAPTER XXX 

PROPOSALS FOR SOCIAL RECONSTRUCTION 

Economic Organization a Steady Growth — From 
time to time in the preceding chapters we have tried 
to show that our social and economic organization is 
the result of a gradual growth. We do not progress by 
leaps and bounds, although at times it appears that a 
great step forward has been taken. Insensibly changes 
are taking place and realization of the changes only 
develops when they have become obvious through the 
difference between present and fairly distant times. 
No sudden great change has much chance of being 
permanent. The instinct of conservatism which is 
strong in us all tends to prevent the success of any 
absolutely radical change. Those steps in progress 
which have appeared to be of great importance can 
usually be traced by the historian to a long line of 
small developments all preparing the way for the 
change. 

Society Dynamic, not Static — In spite of this, from 
time immemorial men have tried to imagine or con- 
struct new schemes of society which would be an im- 
provement on the existing system. From Plato to 
H. G. Wells we have had our Utopians. There is, 
however, a noticeable difference between the Utopias 
constructed in the past and those which are suggested 
in our present generation, for we have not lost the 

424 



PROPOSALS FOR SOCIAL RECONSTRUCTION 425 

desire for the perfect life. The older schemes of state 
reconstruction were static. That is, they were schemes 
for a perfect, completed organization which was to be 
the last word in organization. Perfection, however, 
is the very negation of life. When a thing is perfect 
there is nothing further to strive for. In our very best 
efforts there is always a little short of absolute per- 
fection. We see this in every phase of life — in art, 
in science, in literature, in music. No matter how 
great the artist, writer, or composer, there will always 
be the critic to point out his shortcomings. Our 
modern Utopians realize the fact that the perfect 
society is always ahead of us and can never be present ; 
they know that a society which has no goal toward 
which it strives is dying. Hence we have, instead of 
the older static schemes of a realized perfection, the 
dynamic state — a living system which has all the 
elements of growth. That the suggestions are attempts 
at picturing perfection cannot be denied, but there is 
always the realization that in practice difficulties would 
arise — difficulties to be overcome by careful thought 
and a re-solving of problems. 

All Utopias, however, have as their basis a feeling 
that the existing state is unsatisfactory. Hence the 
very schemes that are propounded as a cure for these 
evils constitute in the first place a criticism. 

Failure of Communistic Experiments — The inventor 
and discoverer is always impatient at the slowness of 
his fellows ; so impatient, in fact, that in schemes of 
social reconstruction in particular, he is anxious to try 
experiments. It may be said at the outset that all 
the schemes that have been tried have proved to be 



426 AN INTRODUCTION TO ECONOMICS 

failures ; but this fact does not detract from the possi- 
bility of the ideas being of great value in a growing 
social organization. Communism has been attempted 
at various times and in various places, occasionally 
with temporary success and ultimate failure, sometimes 
with failure from the start. This does not, however, 
prove that communism is an absolute failure as a 
solution of the social problem. We have seen, in the 
course of our study, that all history proves the growing 
interdependence of human beings. The economic unit 
has steadily grown until, as far as civilized countries 
are concerned, it covers the whole world. No group 
can separate itself permanently from the great social 
organism and hope to have a real effect upon that 
organism. Even if successful for a time, its very 
isolation tends to bring about its own ultimate de- 
struction. 

The idea that man would be better off if he shared 
everything with his neighbors finds support from a 
great number of people who are dissatisfied with the 
existing scheme of distribution. Private property has 
been declared to be at the root of all the evils of 
which they complain. Hence the solution of the 
problem lay, to their minds, in the abolition of private 
property. The supporters of communism, however, 
are comparatively few at present, and the greater 
part of the schemers for a better system pin their 
faith to one form or other of what is called socialism. 

Socialism — It has been frequently necessary to 
remark that words are used colloquially in many 
different senses, and for the purpose of scientific 
discussion it is necessary to give a sharp definition to 



PROPOSALS FOR SOCIAL RECONSTRUCTION 427 

each term used. Terms which are com^mon in political 
thought are probably more subject to varying inter- 
pretations than any others. Take the common terms, 
Democrat and Republican, in our American politics. 
Is it possible to define accurately the meaning of these 
terms, apart from the incomplete definition contained 
in the suggestion that they refer respectively to 
members of the Democratic and Republican parties.'' 
Just as it is impossible to give a definition of these 
two political names, so also is it impossible to define 
socialism in a manner which will satisfy all socialists. 

Moreover, the ideas of the meaning of socialism 
held by those who do not claim to be socialists are at 
infinite variance from the meaning attached to the 
term by its professors. How, then, are we to discuss 
socialism with any degree of satisfaction .f' 

Though the variants of socialism are very numerous, 
there is a certain idea running through all the forms 
which is essentially the same in each. We shall, 
therefore, before discussing one or two of the prin- 
cipal forms, consider the main idea which pervades 
them all. 

Socialist Criticisms — Like all other more or less 
Utopian schemes, socialism commences with a criticism 
of the existing system. The nature of the criticism 
necessarily points out the methods by which the evils 
are sought to be abolished. Social organization has its 
only justification in the satisfaction of the needs of 
the individuals who compose society. Just in so far 
as the organization succeeds in meeting the require- 
ments of its members, is it successful. What are the 
essential needs of the^ members of society, i.e., humanity 



428 AN INTRODUCTION TO ECONOMICS 

at large? They consist of three groups. In the first 
place the physical needs must be satisfied. These 
are the provision of food, clothing, and shelter. Any 
organization which does not make provision for these 
primary needs is an obvious failure. How, then, 
does our present system succeed in this respect ? All 
who are actually alive serve to prove that there is at 
least a measure of success. The socialist, however, 
claims that the measure is so small that it is hardly 
worth considering. He points out the vast inequalities 
in distribution of food, clothing, and shelter; the 
coarse, impure, and insufficient food of the poor ; the 
overabundant and ridiculously elaborate meals of the 
rich. He contrasts the rags which clothe the poorest, 
the inartistically designed and poorly constructed 
clothes of the lower classes, with the garments of the 
wealthy classes, especially the marvelous creations 
which adorn the wives and daughters of the wealthy. 
The hovels in which many thousands of the poor are 
housed and the badly designed and still worse con- 
structed dwellings of the average workman and even 
the houses of the middle class bear no comparison with 
the dwellings of the millionaire. 

A system which allows of such inequalities cannot 
be said in any way to be successful. The criticism does 
not imply, of course, that there should not exist the 
expensive and highly artistic dwellings ; on the con- 
trary, the socialist, as a rule, desires that the number 
of these should be even greater than at present. He 
does say, however, that where these wealthy homes 
are only possible because of the existence of the average 
outrage on architecture and workmanship in which 



PROPOSALS FOR SOCIAL RECONSTRUCTION 429 

the bulk of the population is housed, the system is an 
ugly failure. 

In the second place, society must provide for the 
conventional necessaries. Man does not live by bread 
alone. He is not content, and he should not be con- 
tent, with the bare means of subsistence or even with 
abundance of coarse but satisfying food, warm but 
uncomfortable and inartistic clothing, efficient but 
inconvenient and ugly shelter. He desires, and he 
ought to desire, variety of food, satisfactory in quantity 
and as nearly perfect in quality as is possible. The 
same is true of his clothing and his housing. 

There is more to life, however, than the mere physical 
fact of living. The progress of civilization is the growth 
of the desires of man. The savage is content almost 
with the bare physical necessaries, but the higher 
in the scale of civilization, the greater are the number 
and variety of the desires of the individual. Music 
and leisure to enjoy and practice it; art and the 
knowledge to pursue and appreciate it ; the joy of 
wresting the secrets from nature and advancing 
scientific knowledge — all these and more forih part 
of the real necessaries of life. Luxury exists to-day 
and is often senseless ; it is the expression rather of 
the power of spending than of the desire to enjoy to the 
full the blessings of life. It tends not to the increase 
of man's desires, but rather to the decrease of the 
general satisfactions in order to satisfy the more or 
less inane wants of the idle rich. 

The socialist does not contend that all luxury should 
be abolished. But he does insist that luxury, especially 
the type which is common to-day, has no right to 



430 AN INTRODUCTION TO ECONOMICS 

existence while there are vast masses of the people 
who are reduced almost to the bare level of subsistence. 
He does not share the idea that the refinements of 
ease and of leisure are of themselves immoral ; rather 
the opposite. He insists on the right of all to gain the 
greatest amount of enjoyment and pleasure out of life. 

In these two aspects of the socialist criticism of life 
as it is lived at present, the essential point of the 
criticism is that the method of distributing the prod- 
ucts of our economic energy is fundamentally wrong. 
There are some, of course, who suggest that wealth 
as it is produced should be shared by all equally, but 
this is not necessarily a fundamental principle of 
socialism. Many who call themselves socialists do 
not desire the absolute equality of income for all, but 
recognize the value of a certain amount of diversity of 
income. None, however, will admit that the great in- 
equalities which exist to-day are necessary, still less 
advisable. 

The severest criticisms, however, lie in the realm of 
production rather than in distribution. It might con- 
ceivably be possible to arrange a new method of dis- 
tribution without absolutely reorganizing the basis of 
modern economic life. But the socialists declare that 
the method of production — the competitive method — 
which rules our economic system, is fundamentally 
unsound. Its basis is the belief that scientific selfish- 
ness produces the best and most abundant production. 
We have seen in our account of the competitive system, 
that the real aim of the producing individuals was not 
the rendering of service to the community and exacting 
a reward for such service. The aim was to secure the 



PROPOSALS FOR SOCIAL RECONSTRUCTION 431 

reward — the service was incidental. The farmer 
cultivates the ground for the sake of the price he 
receives for his product, not for the sake of providing 
food for the people. The shipbuilder builds his vessels 
in order that he may gain as large a sum as possible 
from the man who is to use the ships, not in order to 
facilitate the interchange of commodities and so increase 
the welfare of the nations. Incidentally the people are 
fed and the goods are interchanged. But these services 
are performed in a very inefficient manner. Effort 
is not economized, but rather wasted, and wasted on a 
colossal scale. Instances abound. Take the case of 
the retailing of groceries, for example. In any city we 
can see the great multiplication of little stores, each 
with its variety of goods for sale. In none is there a 
complete stock, and customers go from one store to 
another, buying a little here and a little there. In- 
efficient buying on the part of the dealer results in goods 
lying on the shelf in one store while there is a shortage 
in others. In the case of perishable goods, the waste 
is still worse. Goods are actually left to spoil because 
they happen to have been bought too freely by one 
storekeeper, and his customers do not absorb them. 
The bigger stores have realized this waste and have to 
a large extent eliminated it in their own organizations. 
Even in the case of the large chain stores, however, there 
is waste due to competition with independent stores. 

Take production on a larger scale, like the manu- 
facture of steel goods. At times we have the bulk of 
the factories working at full speed, but it is commoner 
for each to be working at less than full speed — some 
of the machinery idle all the time. This, declares the 



432 AN INTRODUCTION TO ECONOMICS 

socialist, means the waste of effort caused by producing 
more machinery than is necessary. Again Httle manu- 
facturers still exist competing for the odds and ends of 
trade with inefficient and more or less obsolete equip- 
ment, taking toll of the muscles and minds of those 
who work it, when the muscular and mental effort 
might be saved by using the more modern tools and 
machines. 

The competitive method, moreover, introduces one 
type of worker whose energies are almost entirely 
waste. The advertiser is absolutely necessary to 
business as it is conducted to-day. Look at our adver- 
tisements of motors. Each manufacturer is striving 
to tell how good his own machine is in as seductive a 
manner as possible. It cannot be true that all are 
equally good, but it is perfectly possible that there is 
little to choose between a score or so of the best. At 
a given price there is probably little real variation in 
quality. Yet the cost of the advertisements accounts 
for a very considerable proportion of the selling price. 
It accounts, also, for a very great amount of what, to 
the socialist, is waste of individual effort on the part 
of advertisement writers, artists, draftsmen, printers, 
and so forth. 

The keynote of the socialist criticism of the existing 
system of economic production is to be found in the 
word waste — waste of effort, of time, and of material. 

With a great deal of this criticism we must needs 
agree. No sane man will refuse to admit that dis- 
tribution of wealth is absurdly inequitable at present. 
Even the wealthiest admit it and often try to minimize 
the evils of the distribution by a voluntary offering of 



PROPOSALS FOR SOCIAL RECONSTRUCTION 433 

part of their wealth to those less fortunate. It will 
also be readily granted that the workman (using the 
term in its broadest sense) is entitled to a greater return 
for his efforts than he actually obtains. 

It is not so freely granted, however, that the leisure 
of the hardest workers at present should be increased. 
We have still too much of the Puritan feeling that pleas- 
ure is evil and that idleness is productive of all sorts 
of mischief. Yet a little thought will be suflScient 
to show that work, except in comparatively small 
quantities, is not of itself a blessing. It is a means to 
an end and there is far too great a tendency to regard 
the means as the end itself. No man can be a good 
citizen whose mind, at its freshest, is used on his work 
alone, and who gives the more or less exhausted brain 
power to the real business of being happy and assisting 
others to be so. We smile at the eccentricities of the 
artist and the inventor, but there is just a little envy 
in our smile. 

A socialist street orator put the whole situation 
very aptly, if his language does seem confused, when 
he said that " what we want is more work and less of it." 
What he meant was, that we should work rationally, 
not wearing ourselves out with toil for a few weeks or 
months, and then lying idle for a similar or longer 
period. Our periods of working should be of shorter 
duration, but they should be steadier. From the point 
of view of economic working, there cannot be any denial 
of this belief. Experience has proved time and time 
again, that long periods of work produce poor workman- 
ship. It is not a mere chance that the bulk of the 
accidents which occur in industry take place toward 



434 AN INTRODUCTION TO ECONOMICS 

the end of the working day. Long periods of un- 
employment, also, tend to produce the unemployable. 
We are very largely creatures of habit, and when we 
get in the habit of doing a certain amount of work 
each day, we do not feel the same desire for idleness 
as when we alternate periods of great effort with periods 
of complete idleness. To put the matter briefly, 
experience proves that the average human being re- 
quires both work and idleness, and it is false economy 
to allot the idleness to one group of individuals and the 
work to another. That sort of " division of labor " 
is one of the few varieties which do not conduce to 
economic eflSciency. 

Turn now to the question of waste in the competitive 
organization. The whole trend of development, as 
we have attempted to show in the preceding chapters, 
is towards the elimination of the very competition 
which is still sometimes spoken of as the " life of 
trade." The strongest arguments in favor of big 
business and unified control are those based on the 
economies resultant from the removal of competition. 
Perhaps the average individual, especially in America, 
will not admit the importance which the socialist 
places upon this economic waste. In the case of 
advertising, for instance, there are advertising asso- 
ciations all over the country whose members will 
always be ready to justify their occupation upon 
sound economic grounds, and it is worth while for a 
moment to consider some of these grounds. It is 
asserted that nothing can be sold to people unless they 
know about it. Indeed, some people cannot be made 
to appreciate a good article unless its goodness is 



PROPOSALS FOR SOCIAL RECONSTRUCTION 435 

drilled into them by constant repetition. Does the 
advertiser, however, really base the justification of his 
business upon this belief? Admitting its truth, as 
we are forced to do, does this justify the advertising 
that occupies so large a space in our magazines and 
newspapers? Most advertising experts will agree 
that, while advertising will help to sell for a certain 
time a commodity which does not nearly live up to the 
advertised recommendations, unless the commodity 
has a real value or rather unless it satisfies a real 
desire, advertising will not secure permanent sales. 
Still, there are few commodities which are as good as 
the advertisements declare, and a well-advertised article 
will sell more rapidly than a better one which is not so 
widely known. There is a strong tendency nowadays 
for advertisements to be more accurate in their de- 
scriptions of the advertised goods than was formerly 
the case, but the best that can be said is that a cer- 
tain amount of advertisement is an absolute necessity. 
The degree to which this method of attracting attention 
to goods is carried at the present day is, however, far 
greater than can possibly be justified. If we cannot 
admit the full strength of the socialist's argument, at 
least we must admit that there is a great deal to be said 
for the criticism he urges. 

In the main, therefore, we may say that the criticisms 
against our present economic system, which are urged 
by socialists and by others who would indignantly 
repudiate the title, are sound. The disagreement 
comes with the suggestions for the removal of the evils. 
We must now turn our attention to these suggestions 
and endeavor to see what value, if any, there lies in the 



436 AN INTRODUCTION TO ECONOMICS ; 

various socialist and other programs of social recon- 
striiction. 

The Central Idea of Socialism — The socialist pro- 
grams, multitudinous as they are, have as a rule one 
idea in common ; that idea is that society should not 
be based upon private enterprise, with the stimulus of 
private profit. The socialist rejects entirely the idea 
of competition, and substitutes therefor the idea of 
co-operation. He removes the aim of profit and in 
place of it substitutes the aim of service. Where, under 
the present economic system, private individuals own 
the means of production, including the land, and where 
the landless and propertyless part of the population 
bargains for the sale of its labor, the socialist would 
have the means of production owned in common, and 
of distribution on the basis of the needs of the in- 
dividual. The socialist ideal is that each should 
receive according to his needs and give (in service) 
according to his capacity. 

Revolutionary Socialism — As we have said, there 
are many forms of socialism, but we shall distinguish 
three main divisions. There are those who believe 
that the competitive system will fall of its own weight. 
They think that the whole tendency of modern economic 
development is toward the elimination of competition 
and the evolution of big businesses, resulting in a con- 
centration of wealth in the hands of a very few people. 
This concentration will, of itself, produce a revolution 
against the possession of enormous wealth in the 
hands of a very small proportion of the population, 
and the state will take over the responsibilities of 
production from the hands of those who have con- 



PROPOSALS FOR SOCIAL RECONSTRUCTION 437 

trolled it. Those who hold this view are prepared 
to let the elimination of competition proceed of its 
own accord until the time is ripe for the national 
organization to assume control, and they believe that 
this ultimate assumption, regarded as an inevitable 
fact, will require a revolution. 

There is much that is true in the first contention of 
the revolutionary socialists. There is an undoubted 
tendency to eliminate competition — ^ we have already 
noticed this fact. But because a tendency exists, it 
does not necessarily follow that it will be carried out 
to its logical conclusion. Even in the organization 
of big businesses we have already noticed the fact that 
if the business is organized on too large a scale the law 
of decreasing returns comes into force. There is a 
limit to the size of each industry, as far as the individual 
plant is concerned. The same is also true so far as the 
industry as a whole is concerned, especially when 
geographical conditions are taken into consideration. 
It would be absurd, for example, to have the street 
railways of the different cities of this country run by a 
single national organization, whether that organization 
be privately or publicly owned. 

Neither does it follow that, even if the tendency to 
the elimination of competition is carried to its logi- 
cal conclusion, the government will be forced by 
a revolution to assume operation. Many possibilities 
may occur in the meantime to give increased control, 
without actual ownership by the government. Revo- 
lutions, moreover, are always dangerous. This does 
not mean that they are never necessary. The history 
of the United States shows that sometimes the only 



438 AN INTRODUCTION TO ECONOMICS 

solution of a political difficulty is a revolution. But 
a sudden change of the form of government or of the 
economic system is, as a rule, not a thing to be desired. 
Until recent years, the tendency of socialist thought 
was against revolution and was directed towards 
evolution. 

State Socialism — The evolutionary socialists, or as 
they are better called, the State Socialists, believed 
in the gradual assumption by government of all the 
means of production. They would begin by securing 
government ownership of the principal natural monop- 
olies, like the means of transport, the provision of 
light and power, and so forth, and then gradually 
extend the scope of government economic effort until 
all industry was carried on under government owner- 
ship. It was taken for granted that the land would be 
nationalized and then the mines. 

In support of the contention that the government 
could operate successfully the great business organi- 
zations the socialists pointed out the fact that already 
the government carried on great industries. The 
carriage of the mails alone represents a great business 
organization. Governments in different countries have 
owned and operated railroads. In time of war, the 
government has been compelled to assume control of 
privately owned industries and, in spite of the difficulties 
incidental to hurried reorganization, these industries 
have, on the whole, been efficiently managed. 

In the smaller organizations of government like 
the municipalities, much greater strides have been 
made in government ownership and operation of 
industry. Municipal street railways, gas and electric 



PROPOSALS FOR SOCIAL RECONSTRUCTION 439 

systems, water systems, and so forth, are common, 
and they are as a rule, fairly well managed ; so well, 
in fact, that there are very few cases where the muni- 
cipalities would care to go back to the system of private 
ownership. Municipal markets, dairies, theaters are 
becoming commoner every day. To all these instances 
of socially ouTied and operated business, the socialist 
points, and draws the moral that what can be done in 
one place and with one industry can be done in another 
and with other industries. All that the state socialist 
asks is that the governments, including the local 
governments as well as the national, should gradually 
increase their economic functions until private enter- 
prise in business and private ownership of the means of 
production, should cease. 

Now this proposition assumes, among other things, 
that governments are both honest and efficient. If 
they are neither, there is very little chance of success. 
If we could be reasonably sure that government officials 
would only be appointed on the basis of efficiency for 
their job, and that their administration should be 
honest, there is no reason to suppose that government 
ownership and operation of industry would not be 
considerably more successful than the present method. 
Honesty and efficiency on the part of government, 
however, is determined by the interest displayed in 
government by the people as a whole. Government 
officials can be dishonest and attend to their own 
interests, when they know that the supervision of 
their work is inefficient. When the public only cares 
for the excitement of politics, and cares for that only 
spasmodically, as seems to be the case at present, there 



440 AN INTRODUCTION TO ECONOMICS , 

is little chance that governments will be really efficient. 
We are apt, however, to underrate rather than to 
overrate government efficiency ; and at the same time 
we are just as apt to err in the other direction when 
dealing with private enterprise. We assume efficiency 
in private enterprise, and we assume inefficiency in 
public enterprise. Neither assumption is warranted by 
the facts. There is an immense amount of inefficient 
business conducted under private enterprise, just as 
there is also a great deal of dishonesty. On the other 
hand there is much careful, painstaking, and really 
sound work done under national and municipal govern- 
ments. 

The great danger to be apprehended j^from govern- 
ment operation, as it has been suggested by the state 
socialists, is what is colloquially known as " red tape." 
A great many socialists, having seen the actual opera- 
tion of government control of industry, in England 
in particular, have reluctantly given up their ideas. 
This is particularly true of the labor parties and trade 
unionists. Before discussing the third form of social- 
ism, we may spend a moment in considering some 
objections to socialism in general. 

Objections to Socialism — Assuming that a socialist 
state were organized, every one, it is argued, would be 
on a dead level ; there would be no stimulus to increased 
effort, and therefore there would be little chance of 
real progress. Government would tend rapidly to 
laying down the law as to what is to be produced, 
and those individuals, who were comparatively few in 
number, would be unable to satisfy unusual require- 
ments. Inventors would have little chance of obtaining 



PROPOSALS FOR SOCIAL RECONSTRUCTION 441 

consideration for their inventions, as the government 
would always be inclined, through its officials, to be 
too conservative. Hence business and economic effort 
generally would be inclined to stagnate. 

It is generally felt by opponents of socialism that 
personal initiative, which means so much in progressive 
civilization, would be lost. There would be no in- 
centive to effort, is the argument, and therefore there 
would be no effort except the perfunctory effort of 
the traditional government employee. To these argu- 
ments, the socialist replies, first, that there is nothing 
to support the idea that there would be no personal 
initiative- under government employ beyond the state- 
ment of the opponents of socialism, and second, that 
when these opponents say that there would be no in- 
centive to work, what they mean is that there would be 
no financial incentive. We have already discussed the 
question of incentives to work in a previous chapter and 
noted that there are many besides the merely pecuniary 
stimuli. Finally it is said that the traditional govern- 
ment employee is merely traditional — he does not 
exist in fact to anything like the extent that is generally 
supposed. ' 

In any case the newer socialism provides for a system 
of control of industry which will secure capable organ- 
ization and efficient work. 

Guild Socialism — The modern idea of what has 
been called in England, Guild Socialism, has much in 
common with a developed French idea of syndicalism. 
Perhaps it will be better to start with the French idea 
first before we attempt to discuss its English and 
American equivalents. French political philosophers 



442 AN INTRODUCTION TO ECONOMICS 

have been pointing out for the past dozen years or so, 
that the rough division of economic society into em- 
ployer and employed is unsatisfactory for many reasons. 
We are all associated with one another, but there 
are groups which are closely associated. In fact the j 
greater the advance of civilization, the greater is the j 
number of groups with which one individual becomes I 
connected. A man is closely related with his fellow j 
workers in the trade by which he earns his living. He ' 
is associated with his fellow church members, club , 
members, benefit society members, athletic association 
members, and so on. It is, however, with the members 
of his particular industry that he is most closely 
related. This means that the association is not partic- 
ularly with the craft which he exercises. A man may 
be a carpenter and be more closely related to the brick- 
layers who are employed in the same business unit than 
with carpenters belonging to a different unit. The 
unit is rather the industry than the trade. It is 
becoming more and more recognized that the actual 
workers in an industry must have a greater say in the 
conduct of that industry than has hitherto been the 
case. 

A satisfactory trade organization will include among 
its management not only the organizers but also 
those who are engaged in carrying out the organization, 
or their representatives. Some of the foremost of the 
French political thinkers believe that society is tending 
to become more and more organized into trade groups, 
each group organizing and controlling its own trade — 
the railway men controlling the railways, the spinners, 
weavers, and dyers controlling the textile trades, and 



PROPOSALS FOR SOCIAL RECONSTRUCTION 443 

SO forth. Already we find the professional classes 
organized in this manner ; the lawyers actually control 
the legal profession; the doctors lay down the rules 
under which the medical profession is conducted. 
Now there is only a difference in degree between control 
and actual ownership. If all those engaged in the 
building trades, that is, the bricklayers, carpenters, 
plumbers, with their executive heads, actually control 
the industry so that they can lay down the prices to be 
charged for their product, and the wages to be paid 
to the members, this amounts to practical ownership 
of the industry. 

The guild socialists of England have had experience 
of government control and do not wish to add to that 
experience. They demand the nationalization of the 
principal industries of the country, but they object 
to government management. They ask that the 
industry be controlled by those employed in the 
industry — the railway workers (using the term workers 
in its broad sense) controlling the railways, and mine 
workers the mines, the transport workers managing 
the transport industries in each of the main groups of 
those industries. 

In America we see the development of this idea in 
the suggestion of the railway brotherhoods in regard to 
the future control of the American railways. They 
desire a strong representation on the management 
board for the railway unions, the whole system being 
worked so that a good living wage can be paid to all 
employees and the profits of the system used to reduce 
rates to shippers. 

It is outside our province at present either to praise 



444 AN INTRODUCTION TO ECONOMICS 

or criticize these schemes. It might be suggested, 
however, that too much stress is laid by guild socialists 
on the importance of the producers in connection with 
the industries of a country. After all, the industry does 
not exist for the sake of the workers, but for the sake 
of the consumers, and it would hardly seem right to 
place the consumers at the entire mercy of the pro- 
ducers. Even the suggestion, true as it is, that the 
producers themselves are the consumers, does not 
affect the argument. If there is to be such an arrange- 
ment as will remove the profit stimulus, there should 
be representatives on the management who will see 
that the interests of the consumers are cared for. 

Conclusion — In an introductory book it is quite im- 
possible to give adequate consideration to the infinite 
variety of suggestions for the improvement of economic 
society. We have attempted to describe society as it is, 
and to point out the laws under which it works. We 
have admitted that the results are far from being all that 
could be desired, and the realization of this fact should 
in itself be a stimulus to the search for a better organ- 
ization. There only remains to be said the fact that, 
whatever be our present suggestions for improvement, 
they are bound to change as conditions change and as 
experience shows them to be unsatisfactory. It is 
just as bad, however, to denounce all new schemes 
as to accept blindly one panacea or another. Names, 
whether they be the names of socialism, anarch- 
ism, bolshevism, or individualism mean, in them- 
selves, simply nothing. No one is prepared with 
a satisfactory definition which really covers the whole 
content of the terms. What we must seek is the 



PROPOSALS FOR SOCIAL RECONSTRUCTION 445 

reality behind the label, using careful scientific judg- 
ment and not blind passion. 

Tub thumping at street corners will lead us no 
further than ignorant rhetoric in newspapers. In 
order to amend our society we must first understand 
it. Our study of economics should serve as a basis 
upon which to build a real knowledge of the economic 
structure of the present civilization. It rests with the 
student to fill in the many and deep gaps which have 
been left and to apply his knowledge to the task of 
so reconstructing society that the evils of which we 
are conscious shall be things of the past. 



BIBLIOGRAPHY 

1. General Works 

Marshall, Alfred. Principles of Economics. Seventh 

edition. New York. 
Seager, Henry. Principles of Economics. Second edition. 

New York, 1917. 
Seligman, E. R. a. Principles of Economics. Seventh 

edition. New York, 1916. 
Taussig, F. W. Principles of Economics. Second edition. 

New York, 1915. 
Ely, R. T. Outlines of Economics. Third edition. New 

York, 1916. 
GiDE, C, AND RisT, C. History of Economic Doctrines. 

New York, 1915. 
Marshall, Wright, and Field. Materials for the Study of 

Elementary Economics. Chicago, 1916. 

2. Economic History 

BoGART, E. L. Economic History of the United States. New 

York, 1914. 
CoMAN, Katherine. The Industrial History of the United 

States. New York, 1910. 
HoBSON, A. The Evolution of Modern Capitalism. New 

York, 1916. 
Cunningham, W. The Growth of English Industry and 

Commerce. Cambridge, England, 1912. 
Innes, a. D. England's Industrial Development. London, 

1916. 

447 



448 AN INTRODUCTION TO ECONOMICS 

Ogg, F. a. The Economic Development of Modern Europe. I 
New York, 1916. 1 

3. Money and Banking 

Jevons, W. S. Money and the Mechanism of Exchange. I 

New York. 
Withers, Hartley. The Meaning of Money. New York, 

1916. 
HoLDswoRTH, J. T. Money and Banking. New York, 1917. 
Willis, H. Parker. American Banking. Chicago, 1916. 

The Federal Reserve System. New York, 1915. 

Conway and Patterson. The New Bank Act. Philadel- 
phia, 1914. 

4. International Trade 

Bastable, C. F. The Theory of International Trade. New 

York, 1903. 
Hough, B. Olney. Ocean Traffic and Trade. Chicago, 

1916. 

Practical Exporting. New York, 1918. 

Hobson, J. A. International Trade. New York, 1904. 
Taussig, F. W. Tariff History of the United States. New 

York, 1896. 

Some Aspects of the Tariff Problem. Harvard 

University Press, 1915. 

EscHER, Franklin. Elements of Foreign Exchange. New 

York, 1918. 
Patterson, E. L. S. Domestic and Foreign Exchange. 

New York, 1917. 
Withers, Hartley. Money Changing. London, 1913. 

5. Business and Industrial Organization 

Veblen, Thorstein B. The Theory of Business Enterprise. 
New York, 1904. 



BIBLIOGRAPHY 449 

DiEMER, Hugo. Industrial Organization and Management. 

Chicago, 1915. 
Hirst, F. W. Monopolies, Trusts, and Cartells. London, 

1905. 
Ely, R. T. Monopolies and Trusts. New York, 1912. 
Clark, J. B. The Problem of Monopoly. New York, 1904. 

6. Labor Problems 

Adams, T. S., and Sumner, H. Labor Problems. New 

York, 1917. 
Webb, Sidney and Beatrice. History of Trade Unionism. 

New York, 1911. 

Industrial Democracy. New York, 1902. 

Commons, J. R. History of Labor in the United States. 

New York, 1918. 
HoxiE, R. F. Trade Unionism in the United States. New 

York, 1917. 
Cole, G. D. H. Self-Government in Industry. New York, 

1918. 

7. Distribution and Social Reform 

Veblen, Thorstein B. The Theory of the Leisure Class. 

New York, 1809. 
HoBsoN, J. A. Work and Wealth. New York, 1914. 
George, Henry. Progress and Poverty. New York, 1911. 
KiRKUP, Thomas. The History of Socialism. New York, 

1909. 
Ensor, R. K. Modern Socialism. New York, 1907. 
Marx, Karl. Capital (trans.). London, 1906. 
MacDonald, J. R. The Socialist Movement. New York, 

1911. 
Snowden, Philip. Socialism and Syndicalism. London. 
Eltzbacher, Paul. Anarchism (trans.). New York, 

1908. 



450 AN INTRODUCTION TO ECONOMICS 

8. Public Finance 

Adams, H. C. The Science of Finance. New York, 1899. 
Bastable, C. F. Public Finance. Third edition. New 

York, 1903. 
Plehn, C. C. Introduction to Public Finance. New York, 

1916. 
Dewey, D. R. Financial History of the United States. 

New York, 1915. 
Seligman, E. R. a. Essays in Taxation. New York, 1913. 



INDEX 



Acceptance, 280 
Accommodation loan, 202 
Advertising, 434 

Agents of production, 55, et seq. 
Agricultural stage, 18 
Agriculture, 51 

American, 94 

primitive, 91 
American Federation of Labor, 376 
Arbitrage, 286 
Arbitration, 386 

Balance of trade, 265, 301 
Bank, 191, et seq. 

debtor and creditor, 200 

loans, 201 

notes, 193 
Barter, 161 
Bills of lading, 279 
Bimetallism, 178 
Bonds, 86, 87 
Bonus systems, 367 
Boycott, 387 
Business, 77 

future element in, 310 

Call loan system, 217 
Canadian banking system, 243 
R Capital, 51, 61, 95, 98 

flow of, 147, 306 

loans, 202 
Cattle as money, 162 
Chartered companies, 81 
Check payments, 269 
Clearing house, 197 
Coinage, 171, 172 

debasement of, 172 

depreciated, 173 

subsidiary, 177 



Collective bargaining, 379 
Commercial bills, 283 
Commercial loans, 203 
Communal tillage, 92 
Communism, 425 
Competition, 106 

idea of, 32 

latent, 157 

meaning of, 33 
Competitive system, 34-38 
Conciliation, 386 
Conditions of labor, 381 
Consular invoice, 278 
Consumer's surplus, 139 
Consumption, 44-46 
Co-operation, 395 
Co-operative production, 398 
Copyrights, 151 
Corporations, 85, 88, 106 
Craft union, 374 
Creative instinct, 352 
Credit instruments, 191 
Crises and panics, 229 
Currency, elastic, 186 

fluctuations in demand for, 185 

inflation of, 187 

payments, 270 

United States, 180 
Custom, 40 

Deductive method, 8 
Demand, curve of, 137 

elasticity of, 129, 158 

latent, 130 

law of, 133, et seq. 
Department stores, 89 
Dependent period, 16 
Deposit reserves, 195 

system, 192, 194 
451 



452 



INDEX 



Development, 20-21 
Diminishing utility, 122 
Discount, 203-20-1 

rate, 221, 230 
Distribution, 320 
Division of labor, li), Gl-63 
Documented draft, 280 
Domestic exchange, 209, et seq. 
Dominating instinct, 3;)3 
Dose of capital and labor, 69 
Draft payments, 271 
Dumping, 303 

Duties, protective and revenue, 288 
Dynamic civilization, 22 

Economic freedom, 27, 37 
Economic functions of government, 

407, et seq. 
Economic history, 15 
Economic laws, 6-7 
Economic problem stated, 25 
Economic imit, 19 
Economics, defined, 2, et seq. 
Effective demand, 126 
Efficiency, 339 
Elasticity of currency, 235 
Elasticity of demand, 129 
Equality of sacrifice, 402 
Equation of indebtedness, 265 
Excess profits, tax, 405 
Exchange, factors of, 133-136 

mechanism of, 249 

rate of, 284 

Factory organization, 103 

system, 98 
Federal Reserve Act, 224, et seq. 
Federal Reserve bank notes, 237 
Federal Reserve notes, 231 
Fiat money, 187 
Finance bills, 284 
Foreign exchange, 273, et seq. 
Foreign payments, method of, 276 

Gild socialism, 441 
Gild system, 27, 96 



Gold, 181, 182 

movements, 266 

causes of, 286 

payments, 270 

points, 275 

shipments, cost of, 274 
Government ownership, 412, et seq., 

438 
Gresham's Law, 175 

Holding company, 113-116 
Hours of labor, 382 

Idleness, 351 
Index numbers, 188 
Inductive method, 10 
Industry, 77 

government regulation of, 27-28, 
37, 409 

location of, 64 
Industrial stage, 13 
Industrial Union, 373 
Interest, 326 

rate, 285 
International, definition of, 254 

price, 263 

trade, 256-258 

value, 260 
Inventions, 22 
Investment, 307 
Iron law, 359 
I. W. W., 378 

Joint-stock companies, 84 

Kartels, 109 

Labor, 56 

as a commodity, 34, 357 

definition of, 355 

division of, 19, 61-63 

market, 357 

organizations, 370, 374 
Land, 55 

Law of comparative cost, 256 
Law of demand, 136 



INDEX 



453 



Law of diminishing returns, 73 

Law of increasing returns, 71-72 

Law of supply, 137 

Leisure, 434 

Letter of credit, 278 

Lockout, 385 

Low wages, a cause of poverty, 345 

Luxuries, 42 

Manufacture, 96 
Margin of cultivation, 324 
Marginal utility, 123 
Market, definition of, 143 

price, 141 
Mercantilism, 301 
Metallic money, 169-170 
Mint par, 273 
Money, 162, et seq. 

and price, 181 

as a measux-e of value, 167 
Monopoly, 80, 111, 116-118, 146, 

151-156, 340, 410 
Monopoly price, 157-159 

Nation, definition of, 254 
National banking act, 207, et seq. 
National bank notes, 210-213 
National system, 298 
Necessities, physical and conven- 
tional, 23, 24, 40 
Normal price, 144 

Opportunity, 338 
Organizing instinct, 353 

Panics, 229 
Partnerships, 79, 82 
Pastoral period, 17 
Patents, 151 
Payment by tale, 174 
Perverse elasticity, 212 
Piece wages, 365 
Pools, 110 

Poverty, causes of, 341 
Price agreements, 107 
Price, definition of, 127 



Price, equation of, 184-185 

fluctuations, 144 

international, 263 

market, 141 

measurement of, 188 

monopoly, 157-159 

normal, 145 

par and investment, CG9 

stability, 149, 317 
Producer's surplus, 140 
Production, 28, 49 et seq., 66, 101, 

156 
Profits, 66, 329 
Profit sharing, 369, 391 
Progress, definition of, 24 
Progressive taxation, 405 
Proportional taxation, 405 
Protection of young industries, 292 
Protection and cheap labor, 302 
Protective taxation, 287 
Psychology, 3 

Quasi-rent, 326 

Rack-renting, 29 
Real wages, 362 
Rediscount, 223 

market, 228 
Regulated companies, 80 
Rent, 322, 325 
Reserves, control of, 220 

cost of, 240 

under National banking act, 213- 
219 
Revenue taxation, 287 
Revolutionary Socialism, 436 
Right to organize, 372 
Right to work, 351 
Rochdale pioneers, 395 

Satisfaction, present and future, 124 
Scientific management, 64, 104 
Seigniorage, 175 
Selling biu-eaus, 110 
Shop steward, 378 
Silver dollars, 179 



454 



INDEX 



Socialism, 426, et seq. 

objections to, 440 
Society djTiamic, not static, 424 
Speculation, 311 

control of, 31S 
Standard of living, 3G1 
Standard wage, 380 
State Socialism, 438 
Statistics, 304 

Stock exchange speculation, 314 
Stocks and shares, 312 
Strikes, 384 
Supply curve, 140 
Supply, demand and price, 129 

law of, 137, et seq. 

Taxation, equality of, 401 

revenue and protective, 287 
Thriftlessness, a cause of poverty, 

347 
Time wages, 364 
Token money, 177 
Trade acceptance, 250 
Trade, early, 78 

marks, 153 

nature of, 247 

union methods, 384 

unions, 374 



Transport, cost of, 264 
Trusts, 112 

Unemployment, 345 

Union label, 387 

United States Shipping Board, 

419 
Utilities, 44, 52, 53 
Utility, diminishing, 122 

marginal, 123 
Utopians, 424 

Value, definition of, 120 

intrinsic, 125 

in use, 163 
Velocity of circulation, 183-184 

Wages, iron law of, 358 

and labor cost, 302 

method of payment, 364 

real, 362 
War, lessons of, 415 
Waste, 101, 432 
Wealth, causes of, 335 

consumer's, 60 

definition of, 42 

incentives to, 348 
Work, incentives to, 351 



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